The Importance of Entrepreneurship to Economic

Transcription

Canada •United States
LAW INSTITUTE
Volume Thirty-Three, No. 1
2007
Case Western Reserve University
School of Law
1
Cite as:
CAN-U.S. L.J.
The Canada-United States Law Journal (ISSN 0163-6391) is published by
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In addition to articles and discussions compiled from the transcripts of the
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This issue went to press in January, 2008.
CANADA-UNITED STATES LAW
JOURNAL
2007-2008 Editorial Board
Editor-in-Chief
Megan McCarthy
Managing Editor
Kelly Schmidt
Michael Jones
Asim Khan
Kyle McCoy
Margaux Day
LerVal M. Elva
Michael Emancipator
Ryan Galloway
Sally Kim
Executive Editors
Pragati Nayak
Will Randall
Associate Editors
Mark Klinko
Carolyn Kobus
Jason Kral
Brett Lamborn
Ryan Quinn
Adam Roberts
R. Monty Silley
Matthew Weinbaum
Eric Stephens
Matt Troy
Janaki Umarvadia
Luke Wake
J. Hunter Whyte
Faculty Adviser
Dan Ujczo
Student Publications Coordinator
Alice Simon
International Research Librarian
Andrew Dorchak
The Canada-United States Law Journal is published by the CanadaUnited States Law Institute.
2
CANADA-UNITED STATES
LAW INSTITUTE
Gary J. Simson
Dean
Joseph C. Hostetler-Baker &
Hostetler Professor of Law
School of Law
Dr. Ian Holloway, Q.C.
Dean
Professor of Law
University of Western Ontario
Faculty of Law
National Directors
Richard Gordon
Professor of Law
School of Law
Chios Carmody
Professor of Law
University of Western Ontario
Faculty of Law
Managing Director
Daniel D. Ujczo
School of Law
Program Coordinator
Deborah Turner
School of Law
Executive Committee and Advisory Board
Founder
Sidney Picker, Jr.
Chair
Dr. Henry T. King, Jr.
Executive Committee
Donald B. Cameron, Jr.
Troutman Sanders LLP
James P. McIlroy
McIlroy & McIlroy, Inc.
Richard O. Cunningham
Steptoe & Johnson, LLP
R. Richard Newcomb
Baker, Donelson, Bearman,
Caldwell & Berkowitz, PC
Lawrence L. Herman
Cassels Brock & Blackwell, LLP
Selma M. Lussenburg
Formerly of OMERS
J. Michael Robinson, Q.C.
Fasken Martineau DuMoulin,
LLP
Graham E. Taylor
The Dow Chemical Company
Advisory Board
Joseph W. Bauer
The Lubrizol Corporation
Stephen de Boer
Government of Canada
Cyndee Todgham Cherniak
Lang Michener LLP
David Crane
The Toronto Star
Stephen E. Flynn
Council on Foreign Relations
Paul D. K. Fraser Q.C.
Fraser Milner Casgrain, LLP
Jonathan T. Fried
Exec. Dir. For the Canadian,
Irish, and Caribbean
constituency, IMF
Richard G. Goetz
Dykema Gossett, PLLC
Hon. William C. Graham, P.C.,
Q.C., M.P.
Rt. Hon. Herb Gray, P.C., C.C.,
Q.C.
Chair, Canadian Section,
International Joint Commission
David R. Robinson
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Jon Groetzinger, Jr.
School of Law, Case Western
Reserve University
Paul A. Guthrie, Q.C.
Canadian Pacific Railway
C. Thomas Harvie
Goodyear Tire & Rubber
Company
George Haynal
Bombardier, Inc.
Bill Hearn
McMillan Binch Mendelsohn,
Toronto, Ontario
Jon R. Johnson
Goodmans, LLP
Jack Lessenberry
College of Fine, Performing and
Communication Arts, Wayne
State University
Gail D. Lilley
Blake, Cassels & Graydon LLP
Toronto, Ontario
Rosemary McCarney
Foster Parents Plan of Canada
Douglas McCreery
Spieth, Bell, McCurdy & Newell
Co., L.P.A.
Catherine A. Pawluch
Gowling Lafleur Henderson,
LLP
Stephen J. Petras, Jr.
Baker & Hostetler, LLP
S. Richard Petry, II
Eaton Corporation
Thomas A. Piraino, Jr.
Parker-Hannifin Corporation
Simon V. Potter
McCarthy Tétrault
Daniel M. Price
U.S. Deputy National Security
Advisor for International
Economic Affairs
Silvana Alzetta-Reali
Coca-Cola Ltd.
Matthew Schaefer
College of Law, University of
Nebraska-Lincoln
T. Bradbrooke Smith
Stikeman Elliot, LLP
John A. Terry
Torys LLP
Toronto, Ontario
P. Kelly Tompkins
RPM International, Inc.
Medina, Ohio
M. Catherine Vernon
Formica Corporation
Praveen Goyal
Research in Motion
Washington, DC
On behalf of the Canada-United States Law Institute, the Journal
gratefully acknowledges a grant of support for the 2007 Conference
from the Government of Canada through the Canadian Studies Grant
Programs of the Department of Foreign Affairs and International
Trade/International Academic Relations Division, as well as
additional support from the Canadian Consulate in Detroit, Michigan.
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EDITOR’S NOTES
Volume 33, No. 1 of the Canada-United States Law Journal contains
the proceedings of the Canada-United States Law Institute’s 2007
Conference titled “Comparative Legal Aspects of Entrepreneurship in
Canada and the United States.” Panels of experts presented on a wide
array of topics throughout the conference, ranging from creating and
financing entrepreneurships to examining case studies of successful
entrepreneurships. I extend a heartfelt thanks to all our speakers for their
insightful contributions.
The publication of the proceedings from the 2007 Conference
presents second- and third-year law students the chance to contribute to
the editorial process of a very unique issue. This opportunity would not
be possible without the aid of several individuals. Firstly, I would like to
thank Dr. Henry T. King and Richard Gordon. Together, their experience
and abilities have made both the Journal and the Institute a distinctive
success in the international legal field. In addition, I would like to
sincerely thank Dan Ujczo for all his unerring advice and support. He has
been an invaluable advisor, and I have appreciated his encouragement and
guidance throughout the many meetings, conference calls, and e-mail
communications. Deborah Turner has also been a tremendous asset. I
would like to extend my sincere thanks to her for all her assistance and
support. Additionally, I thank Kelly Schmidt, my Managing Editor,
whose organization and diligence in preparing this issue was beyond
compare. I could not have asked for a better Managing Editor, and I was
impressed with her attention to detail, terrific attitude, and her
management of the staff. Finally, I would like to extend my thanks to the
entire editorial staff of twenty-three Executive Editors and Associate
Editors. They comprise the foundation of the Journal and their
enthusiasm and abilities in finding and citing the supporting sources were
remarkable. The publication of this issue would not have been possible
without the foregoing individuals, and I am grateful to them all.
The editorial staff’s purpose in editing and reviewing the work of
each author has been to improve the readability of each session while
maintaining the essence of the Conference. The most important work
conducted by the staff was the search for and citation of sources that best
supported the speakers’ remarks. Any questions regarding factual
assertions should be directed to the attention of the speakers. Your
continued support and readership is greatly appreciated, and any
comments you may have are always welcome. Thank you.
Megan McCarthy
Editor-in-Chief
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Canada •United States
LAW INSTITUTE
VOLUME 33, No. 1
2007
PROCEEDINGS OF THE CANADA-UNITED STATES
LAW INSTITUTE CONFERENCE
on
COMPARATIVE LEGAL ASPECTS OF ENTREPRENEURSHIP IN
CANADA AND THE UNITED STATES
Cleveland, Ohio
April 13-14, 2007
Directors of the Canada-United States Law Institute......................................v
Conference Speakers .......................................................................................vii
List of Conference Participants .....................................................................xxi
Conference Introduction and Welcome
Daniel Ujczo.........................................................................................1
Dr. Henry T. King, Jr. .........................................................................3
The Importance of Entrepreneurship to Economic Growth, Job Creation and
Wealth Creation
Introduction – Dr. Henry T. King, Jr. ................................................7
David T. Morgenthaler........................................................................8
Dr. H. Douglas Barber.......................................................................25
Discussion Following the Remarks of David T. Morgenthaler and
Dr. H. Douglas Barber ................................................................38
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Creating Entrepreneurships: Form of Entity; Management Provision
Concerns; Dispute Resolution Provisions; Growth Provisions –
Identification of Rights and Responsibilities of Participants in
Entrepreneurship Including Allocation of Risks
Introduction – Silvana Alzetta-Reali ................................................47
Gail Lilley...........................................................................................48
Michael Wager...................................................................................48
Discussion Following the Remarks of Gail Lilley and
Michael Wager ...........................................................................70
What it Means to be an Entrepreneur
Introduction – Lawrence Herman.....................................................77
A. Malachi Mixon, III ........................................................................79
Discussion Following the Remarks of A. Malachi Mixon, III........90
Private Financing of Entrepreneurships: Sources of Private Financing;
Guarantees (Required Personal or Otherwise); When to go Public (Pros
and Cons); Rights of Financing Parties; Defaults; Capital Formation for
Entrepreneurial Ventures; Tax Considerations
Introduction – Michael Robinson .....................................................97
Morton A. Cohen................................................................................98
David Woolford................................................................................108
Discussion Following the Remarks of Morton A. Cohen and David
Woolford....................................................................................117
Government Assistance to Entrepreneurships: On Local, State/Provincial,
and Federal Levels
Introduction – Ron A. Straatsma ....................................................125
Gilbert B. Goldberg .........................................................................126
John Connell ....................................................................................136
Discussion Following the Remarks of Gilbert B. Goldberg and John
Connell.......................................................................................136
A Case Study of a Successful Private Entrepreneurship
Introduction – Richard Cunningham..............................................141
William A. Davies ............................................................................143
Discussion Following the Remarks of
William A. Davies.....................................................................151
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People Aspects of Entrepreneurs: Personal Service Contacts with Key
Personnel Including Non-compete Clauses, Methods of Reimbursement
for Company Success, Incentives (Profit-Sharing or Other), and Effect of
Immigration Restrictions on Entrance of Possible Entrepreneurs into
Canada and the U.S.
Introduction – Gerald “Jerry” Torma ...........................................159
Benjamin W. Jeffers .........................................................................160
John D.R. Craig ...............................................................................172
Discussion Following the Remarks of Benjamin W. Jeffers and John
D.R. Craig..................................................................................182
The Importance of Venture Capital in Promoting Entrepreneurship
Introduction – Daniel Sandler ........................................................191
Brad D. Cherniak.............................................................................195
Cathy Horton-Panzica......................................................................195
Discussion Following the Remarks of Brad D. Cherniak and
Cathy Horton-Panzica ...............................................................218
Where Do the United States and Canada Stand vis-a-vis Other Countries
Regarding Entrepreneurship?
Introduction – James McIlroy.........................................................225
Dr. Robert Hisrich ............................................................................226
Discussion Following the Remarks of Dr. Robert Hisrich............238
Intellectual Property Aspects of Entrepreneurship: Protection in Patent and
Trademark Areas, as well as Copyright and Know-how Areas (Local and
Foreign); Penetration of Overseas Markets (Directly or Through
Licensing); Possible Industrial Espionage Concerns
Introduction – Raymond Ku. ...........................................................247
Diane H. Dobrea..............................................................................249
James Longwell ................................................................................249
Capitalizing on the Success of Entrepreneurship: IPOs, Private Sales, Tax
Aspects, Residual Interest of Entrepreneurs After Sales of IPOs
Introduction – Richard Gordon. .....................................................275
Elizabeth Dellinger...........................................................................276
Anthony Penhale...............................................................................276
Discussion Following the Remarks of Anthony Penhale and
Elizabeth Dellinger ...................................................................300
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Entrepreneurship: Business and Government
Introduction – Charles Magerman. ................................................305
Hon. Eddie Francis..........................................................................306
Discussion Following the Remarks of Hon. Eddie
Francis........................................................................................318
Where Do We Go From Here?
Dr. Henry T. King...................................................................................327
Daniel Ujczo ...........................................................................................328
Copyright ©2007 Canada-United States Law Journal
iv
DIRECTORS OF THE CANADA-UNITED STATES
LAW INSTITUTE
Richard Gordon is the U.S. Director of the Canada U.S. Law
Institute and an Associate Professor of Law at Case Western Reserve
University. He received his B.A. cum laude with Distinction in
History from Yale in 1978 and his J.D. cum laude from Harvard in
1984. He teaches courses on business associations, corporate
governance, financial sector integrity, and international and
comparative taxation. Prior to coming to CWRU, Mr. Gordon
practiced law at Dewey Ballantine in Washington and taught at the
School of Oriental and African Studies of the University of London,
where he was a visiting lecturer in the law faculty, and the Harvard
Law School, where he was Deputy Director of the International Tax
Program. While at Harvard Mr. Gordon completed extensive field
work on law and development in both Indonesia and rural India, and
advised the government of Indonesia on the reform of tax, company,
and securities laws. After leaving Harvard Mr. Gordon joined the staff
of the International Monetary Fund, where worked on a wide variety
of issues, including public international law, governance, sovereign
debt restructuring, and taxation. Following the attacks of September
11, 2001 he was appointed to the select IMF Task Force on Terrorism
Finance and was a principal author of the report on the role of the IMF
and World Bank in countering terrorism finance and money
laundering. He is a principal author of the book Tax Law Design and
Drafting (Aspen 2001) and the author of numerous scholarly articles
and book chapters.
Chios C. Carmody is the Canadian Director of the Canada-United
States Law Institute. Since 1999, he has been an Assistant Professor,
and since 2004 an Associate Professor of Law at the University of
Western Ontario. He received an Honours B.A. from the University of
Toronto in 1986, a B.Jour. from California State University,
Northridge in 1989, and an LL.B. from the University of Ottawa in
1992, where he was Editor-in-Chief of the OTTAWA LAW REVIEW. He
was subsequently called to the Bars of Ontario (1994) and New York
(1995). He later received an LL.M. from the University of Michigan in
1997 and an S.J.D. from Georgetown University in 2000. Professor
Carmody clerked with the Court of Appeal for Ontario and was in
private practice for two years before pursuing his graduate studies.
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Currently, Professor Carmody teaches in the areas of Public
International Law, International Trade Law, International Business
Transactions, and the Law of International Organizations.
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CANADA-UNITED STATES LAW INSTITUTE CONFERENCE
on
April 13-14, 2007
LIST OF SPEAKERS
Dr. H. Douglas Barber, born on a Saskatchewan farm, attended the
University of Saskatchewan obtaining his B.Sc. with Great Distinction, the
Governor General’s Gold Medal and a M.Sc. in Electrical Engineering. As
an Athlone Fellow and NATO Scholar he received his Ph.D. from Imperial
College, University of London in 1965.
Dr. Barber began employment at Canadian Westinghouse, Hamilton,
Ontario, Canada. In 1973 he was one of the founders of Linear Technology
Inc., now known as Gennum Corporation, which designs, manufactures and
markets microcircuits. Gennum has grown profitably at 20% per year and
now employs about 650 people. Dr. Barber was President and CEO when he
retired in 2000. He continues as a Director.
He was a part-time Engineering Physics Professor at McMaster University
from 1968 to 1994. In 2001 he was appointed Distinguished Professor-inResidence. Dr. Barber authored 29 papers and several patents. He speaks
frequently on business, technology, learning, innovation and economic
development.
Dr. Barber was actively involved in Microelectronics initiatives in Canada
including the Canadian Semiconductor Technology Conference, the
Canadian Microelectronics Corporation, the Sectoral Skills Council, the
Canadian Semiconductor Design Association, Micronet and the Strategic
Semiconductor Consortium.
Dr. Barber’s honors include the APEO Engineering Medal, the University of
Saskatchewan C.J. Mackenzie Distinguished Graduate Award, the
Professional Engineers of Ontario Gold Medal, and Engineer of the Year
Award of the Hamilton Engineering Institute. Dr. Barber has received an
Honorary Doctorate of Engineering from the University of Waterloo, an
Honorary Doctorate of Science from McMaster University, and in 1999 was
named Ontario’s Technology Entrepreneur of the Year, receiving the
National Citation for Innovation & Technology. This year Dr. Barber was
appointed as an Officer of the Order of Canada.
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He was a Director of the Strategic Microelectronics Consortium, the
Canadian Advanced Technology Association, the Hearing Industries
Association and the Alberta Microelectronics Corp. He was a member of the
Sectoral Skills Council, the Natural Sciences and Engineering Research
Council of Canada, the National Innovation Strategy, the Ontario
Postsecondary Education Quality Assessment Board and Vice Chair of the
Ontario Science and Innovation Council. He was a founding co- chair of the
National Information Technology Initiative that sponsored eMPOWR
Canada Inc. in 2001, and is a past director of the Golden Horseshoe Venture
Forum.
He is a member of the Electrochemical Society, the Institute of Electrical and
Electronic Engineers, the Hamilton Civic Coalition and the Burlington Post
Secondary Task Force. At McMaster University, Dr. Barber is a member of
the Board of Governors, the Senate and the Directors College. He is Chair of
the Engineering Dean’s Advisory Board. He is a Director of Micralyne Inc.,
NetAccess Systems Inc., DALSA Corporation, and AllerGen NCE Inc. He is
a member of the Conference Board of Canada Leader’s Roundtable on
Commercialization, the Ontario Ministry of Economic Development and
Trade’s Commercialization Advisory Council, the Institute of Quantum
Computing and the Ontario Research and Innovation Council.
Dr. Barber and his wife, June, have raised a family of four whose families
now include eight grandchildren. He is a man of faith with over 30 years of
active involvement in their church.
David T. Morgenthaler is the founder of Morgenthaler Ventures, a 39 year
old venture capital mega-fund with $2.3 billion under management. David
has served as a Director, Chairman, or President of more than 30 companies,
and over the last 39 years he has built a national reputation for industry
leadership and value-added venture capital investing. He served from 1977 to
1979 as the President then Chairman of the National Venture Capital
Association (NVCA). In 1998, he received the first Lifetime Achievement
Award by the NVCA for his work in venture capital and has been inducted
into The Private Equity Analysts Venture Capital Hall of Fame. He received
the first Life Time Achievement Award of the IBF Forum and was named
one of the first two Kaufmann Fellows. He was an Advisor to the Brentwood
Associates Funds, a Limited Partner of Hambrecht & Quist, and Vice
Chairman of the Edison Biotechnology Institute. He is serving or has served
as a Trustee of The Cleveland Clinic Foundation, a Member of the Visiting
Committee of Carnegie Mellon University, the Sloan School of The
Massachusetts Institute of Technology, the Weatherhead School of Business
at Case Western Reserve University, and a trustee of various philanthropic
organizations. He served as the first Senior Vice President-International for
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the Young President’s Organization and as President of the Chief Executives
Organization. He is a member of the President’s Circle of the National
Academics of Science and Engineering, and a member of the Board of
Science, Technology and Economic Policy of the National Academics. From
1957 until 1968, Dave was CEO of Foseco, Inc., a manufacturer of specialty
chemicals financed by J.H. Whitney & Co. Earlier in his career, Dave was a
member of the management team of several young growth companies. He
received both a BS and a MS degree in mechanical engineering from the
Massachusetts Institute of Technology in 1941.
Gail Lilley has been a partner at Blake, Cassels & Graydon since 1986. She
specializes in mergers and acquisitions of businesses for both Canadian and
multinational clients. She has particular expertise in the Canadian aspects of
global business transactions, including the cross-border structuring and
financing of corporate acquisitions. In 2004, Ms. Lilley advised International
Paper on its CAD 1.2 billion sale of Weldwood of Canada Limited to West
Fraser Timber Co., and, in 2005, she acted as Canadian counsel for Fortune
Brands during the Pernod Ricard’s GPB 7.4 billion takeover of Allied
Domecq.
Michael Wager is a lawyer with Squire, Sanders & Dempsey L.L.P., based
in the firm’s Cleveland and New York offices. He focuses his practice on the
representation of private and publicly held entities in matter of securities
regulation, corporate finance, corporate governance, mergers and
acquisitions, and strategic growth. Mr. Wager has served as counsel and
advisor to, and director of several private and public companies. In 1994, Mr.
Wager earned the designation of ADealmaker@ from The American Lawyer
magazine.
Mr. Wager is active in several civic and philanthropic organizations. He is
the vice-chairman (and chair-elect) of the board of the Cleveland-Cuyahoga
County Port Authority and a member of the selection committee for the
American Marshall Memorial Fellowship (an affiliate of the German
Marshall Fund) and as a member of the advisory board of the National
Leadership Council of the Ireland Cancer Center of University Hospitals of
Cleveland. In addition, he serves as a member of the executive committee of
the Jewish Community Federation of Cleveland and the Jewish Council on
Public Affairs. Mr. Wagers has also served as the chairman of a Clevelandbased private equity firm. He frequently speaks on matters involving capital
formation, securities regulation and change of control transactions.
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A. Malachi Mixon, III is Chairman of the Board of and Chief Executive
Officer of Invacare Corporation (IVC;NYC), the leading worldwide
manufacturer and distributor of medical products for the home health care
market. 2005 sales were $1.5 billion. Mal led a leveraged buy-out of
Invacare in 1979, when sales were $19 million.
Mal serves on the boards of The Sherwin-Williams Company (NYSE), The
Lamson & Sessions Company (NYSE) and Primus Venture Partners, a
leading Midwest venture capital firm. He also is a founding investor in MCM
Capital Partners, LP, a Cleveland leveraged buyout company. Additionally,
Mal has been an active investor in several successful Cleveland-area
ventures which became public companies including Royal Appliance
Manufacturing Company (NYSE) and STERIS Corporation (NYSE).
The American Association for Homecare (AAHomecare) presented Mal with
the 2006 Humanitarian Award in September recognizing his industry
leadership. Also during 2006, Mal was honored by the NAACP Cleveland
Branch as the recipient of the 2006 Freedom Fund Award and the Lorain
County Urban League presented Mal with the Whitney M. Young
Humanitarian Award. In November, 2005, the National Conference for
Community and Justice (NCCJ) presented Mal with its 2005 Living and
Giving Award. Mal and his wife, Barbara, were honored in November 2003
by the Achievement Centers for Children for their civic and philanthropic
contributions to Northeast Ohio. In 2002, Mal received the Business
Statesman Award from the Harvard Business School Club of Northeastern
Ohio. He received the American Association for Homecare Leadership
Award in 2001 in recognition of his dedicated leadership in promoting sound
public policy affecting homecare providers and manufacturers. In addition,
he received the Distinguished Citizen Award from the Greater Cleveland
Council, Boy Scouts of America. He was honored as the Master Innovator at
the 2000 Anthem Blue Cross and Blue Shield / Small Business News
Business Conference. In 1999 and 1992, Mal was awarded the International
Business Executive of the Year Award by the Cleveland World Trade
Association. He was honored by the National Multiple Sclerosis Society with
the Hope Award for distinguished civic and community service and the
Students in Free Enterprise (SIFE) Organization presented him with the
America’s Free Enterprise Legend Award in 1997. Mal was inducted in 1996
as a charter member into the Cleveland Business Hall of Fame. The
Paralyzed Veterans of America honored him with the 1996 Corporate Patriot
Award in recognition of his significant commitment to the PVA and to all
those who have sacrificed in defense of our country. The National Society of
Fund Raising Executives Greater Cleveland Chapter honored Mal in 1995 as
Outstanding Philanthropist. In 1992, he was awarded the Inc. Magazine
Master Entrepreneur of the Year Award for Northeast Ohio. The Harvard
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Business School Club of Cleveland honored Mal with the Dively
Entrepreneurship Award in 1984.
A graduate of Leadership Cleveland (1986), Mal’s current civic activities
include serving as Chairman of the Board of Trustees of The Cleveland
Clinic Foundation and the Cleveland Institute of Music. He also serves on
the Visiting Committee of Harvard Business School and the boards of
BioEnterprise and MWV Pinnacle Capital Management, a fund investing in
minority ventures. In 1992, Mal established a chair in entrepreneurial studies
at the Weatherhead School of Management at Case Western Reserve
University in Cleveland, Ohio. In 1997, he established a Mixon Scholarship
in each new freshman class at Harvard College for students from Oklahoma
and Northeast Ohio.
Originally from Oklahoma, Mal is a graduate of Harvard College (BA) and
Harvard Business School (MBA). Between degrees, Mal served four years in
the U.S. Marine Corps, including a year in Vietnam, attaining the rank of
Captain. Combat decorations include the Air Medal with Oak Leaf Cluster
and Navy Commendation Medal with Combat “V”.
Mal and his wife, Barbara, have two children, Elizabeth and Ki, six
grandchildren, and live in Hunting Valley, Ohio. He enjoys hunting, golfing
and playing the piano.
David Woolford, a partner in Cassels Brock’s Business Law and
Entrepreneurial Business Groups, specializes in business law, corporate
finance, e-business, privacy law, and securities law and has published
extensively on the subject of emerging developments in technology law. In
addition to his busy law practice, Mr. Woolford is an active angel investor
(member of the Toronto Angel Group), is Chairman and a director of Virox
Technologies Inc., and holds various other private directorships and advisory
board positions.
Morton A. Cohen joined Clarion in 1981 as chairman of Clarion Capital
Corporation, which was then a closed-end mutual fund investing in public
and privately-held small companies through private placements. After
becoming CEO and assuming sole management of the fund in 1982, he had
the distinction of taking the only Small Business Investment Company out of
bankruptcy in the history of the Program. Clarion Capital today is an active
Small Business Investment Company specializing in private placements in
public companies. Mr. Cohen purchased the fund in 1987 and took it private
in a leveraged buyout in 1989.
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In 1994, Mr. Cohen started Clarion Management Ltd., which managed
Clarion Partners, L.P., a domestic hedge fund, Clarion Offshore Fund Ltd.,
an offshore hedge fund, and Dynamic Equity Hedge Fund, a Canadian-based
hedge fund. In 2006, Mr. Cohen liquidated Clarion Partners, L.P. and
discontinued managing Dynamic Equity Hedge Fund. He continues to
manage Clarion Offshore Fund, Ltd. The three hedge funds had
approximately $140 million in assets at their peak and generated an
approximate 15% return since their inception.
Between 1983 and 1989, Mr. Cohen also managed First City Technology
Ventures, a venture fund investing in small public companies through private
placements, for which he achieved an approximate annual investment rate of
return of 25 percent. Additionally, as chairman and CEO, Mr. Cohen took
Childers Products, a specialty manufacturing company, from $2 million in
losses to $5 million in profits and industry dominance before selling it in
1989 to a New York-based leveraged buyout group.
Prior to joining Clarion, Mr. Cohen operated MAC Management, a
Canadian-based mergers and acquisitions consulting practice. Among his
clients were large Canadian companies, such as Reitman’s, Ltd., Hiram
Walker, Ivaco Industries, and First City Financial, Ltd. (the Belzberg
Family) for which he researched major U.S. acquisition candidates.
Earlier, Mr. Cohen was president of Yorkton Securities, then an institutional
boutique, which is today one of Canada’s leading securities firms. As such,
he was responsible for the firm’s research department and creation of an
institutional research unit. During this time, he was named to the Canadian
Institutional Investor All-Star List in Distilling two years running. Before
that, Mr. Cohen managed research departments and serviced institutional
brokerage clients for a number of Canadian securities firms including:
Kippen & Co., which has since been acquired by Nesbitt Burns and is now
the largest Canadian securities firm; Baker Weeks, for which he was vice
president and the premier U.S. institutional salesman; and Merrill Lynch, for
which he was the top performing salesperson in Canada.
Mr. Cohen is currently a member of the board of directors of Cohesant
Technologies, Inc. Formerly, he was governor of the Montreal Stock
Exchange (1972-73), a member of the board of governors of the National
Association of Small Business Investment Companies (1990-92), and a
member of the boards of directors of Sanyo-Canada, Adac Laboratories,
Abaxis Co., Alexander Energy, DHB Industries, Inc., and Zemex
Corporation. He also served on a Senate committee that rewrote the
legislation for the Small Business Investment Company Program.
xii
Mr. Cohen was a member of the Visiting Committee of the Weatherhead
Business School of Case Western Reserve University in Cleveland, Ohio and
a Trustee of The Jewish Federation of Cleveland. He has also been a major
contributor to various Cleveland institutions and the Miriam Home
Foundation of Montreal.
Mr. Cohen is Chairman of the Investment Committee of the Jewish
Community Federation of Cleveland, which has over $500 million in
investment assets.
A Chartered Financial Analyst, Mr. Cohen holds an MBA in Finance from
the Wharton School at the University of Pennsylvania and a BA in
Economics from Concordia University in Montreal.
Mr. Cohen has an extensive background in Healthcare and Life Sciences
investments having focused the portfolio of Clarion Capital in these areas
over the past eight years. Among his present and past investments are
Conceptus, Genelabs, NexMed, Inc., Johnson & Johnson, ARIAD
Pharmaceuticals, Cepheid, Intuitive Surgical, Abaxis, ADAC Laboratories,
Maxim Pharmaceuticals, and a large number of other investments spanning
the Healthcare field. During the past five years, Mr. Cohen’s portfolio
investments in this sector have generated an internal rate of return of over
200%.
He is also the author of a number of financial articles and has been published
and quoted over the years in Barron’s, Fortune, Business Week, The
Canadian Financial Post, the Wall Street Journal, Crain’s Cleveland
Business, and The Cleveland Plain Dealer.
John Connell is a career public servant with the Public Service of Canada.
He is currently Director General, Small Business Policy, Industry Canada.
His responsibilities include the development of policies and programs
addressing small business development throughout Canada.
Between 1998 and 2003, John served as Senior Chief, Industry and
Knowledge Economy, Finance Canada. He was responsible for analysis and
advice concerning microeconomic investments and policies aimed at
increasing industry productivity and competitiveness in the knowledge-based
economy.
Between 1995-98, John served as a Privy Council Officer in the Economic
and Regional Development Policy Secretariat of the Privy Council Office.
John handled submissions from the Minister of Industry to Cabinet and
briefings on priorities and issues concerning the Industry Portfolio.
xiii
12
Prior to 1995, Mr. Connell had a long and varied career in transportation
policy with Transport Canada, with assignments in Ottawa, Vancouver and
Canberra, Australia.
John engaged in studies leading to Bachelor of Arts (Honours) and Master’s
degrees from Queen’s University in 1979 and 1980, respectively,
concentrating in history, political studies and public administration.
Gilbert B. Goldberg, as District Director, is responsible for directing the
activities of 11 permanent SBA employees; the administration of a business
portfolio of over 6,400 individual loans for a total of more than $604 million;
oversight of the Ohio Small Business Development Center and 17 subcenters; and the coordination for five chapters of SCORE, a volunteer
organization that provides free business counseling. He is also responsible
for the marketing efforts of the two SBA sponsored micro-lenders in the
District as well as the delivery and oversight of the Agency’s 8(a), SDB, and
HUBZone government contracting programs for small business. Gil also
serves as the National SBA representative under the Agency’s Lender
Liaison Program for KeyBank and National City Bank. In addition, he was a
member of the Agency’s Goals Team for four years.
Since his appointment as District Director in 1994, the District Office has
focused its attention on putting the customer first by instituting a “cut the red
tape campaign” and by holding the staff accountable to quantifiable
performance standards through individual empowerment. This bottom line
focus on the customer has enabled the District Office to outpace the nation in
loan growth in FY95, FY96, FY97, FY98, and FY99. For FY05 the Agency
recognized the District Office as the national leader in 7(a) loan growth.
The district in FY99 also developed a campaign that enabled it to achieve
record loan growth for African Americans and Hispanics. Crain’s Cleveland
Business recognized the results of the campaign in a November 22, 1999
commentary by publisher Brian Tucker entitled “SBA, local banks are right
on target.”
In FY2000, the District developed a unique initiative for the economic
revitalization of the City of Youngstown by combining SBA resources with
those from the banking community and the City. The revitalization initiative
couples SBA guaranteed loans with supplemental equity funding and
economic assistance from the City of Youngstown. The initiative was
expanded to Akron and Toledo in 2002 and 2003 respectively. The District
has also developed a similar type of initiative with Cuyahoga County, The
xiv
Urban League of Greater Cleveland, Case Western Reserve University, and
the Hebrew Free Loan Association for the City of East Cleveland.
Before coming to the SBA as District Director in 1994, Mr. Goldberg spent
20 years in commercial banking. The last ten years were devoted to middle
market and entrepreneurial business development in Northern Ohio. He also
served as Assistant Treasurer for the Lender Mortgage Company in
Cleveland, where he was responsible for treasury operations, including cash
management and banking relations. Before that, he was a Vice President at
Chase Bank of Ohio.
Mr. Goldberg holds a bachelor’s degree in Foreign Service from Georgetown
University and a master’s degree in Business Administration from the
University of Notre Dame.
Gil resides in Shaker Heights with his wife Marcia. They have three grown
children.
William A. Davies was born in Argentina of an Irish Argentine family,
raised in Brazil and educated in the United States. He speaks English,
Spanish and Portuguese. He graduated from Purdue University in Economics
and has a Degree of JD, cum laude, from Indiana University School of Law.
During his professional life, William A. Davies has worked for a variety of
private sector enterprises.
After service in the United States Army he became a Reinsurance
Representative of Lincoln National Life Insurance Company with
responsibility for Latin America and the Caribbean, it is here that his interest
in working with Governments for the benefit of private enterprise was
developed as the Life Reinsurance business is highly regulated and a
significant part of servicing the Life Insurance company clients was lobbying
government on their behalf.
He then pursued a legal career; First with Cahill Gordon Reindhel & Ohl a
Wall Street law firm where he had the good fortune to work closely with the
former legal adviser to the US State Department who was then a senior
partner at the firm; Second with Motorola Inc. where he held successively
positions of responsibility advising the business sectors. This included 5
years in Geneva Switzerland where he was very active with the fledgling
European Commission in the lobbying of the necessary rules for the
Common Market while not hindering the conduct of business.
xv
13
He served as Vice President and Assistant General Counsel and then as VP
and Director of Technology Transfer. He also was the founder and architect
of the Motorola Government Relations Team for Latin America, which he
successfully led for six years.
He then became a Senior Principal for the professional services firm of
DeLevante y Asociados, Panama, R.P. where he consulted for clients
throughout the Americas on spectrum, telecommunications and standards
issues.
He is currently a General Manager and President of Research in Motion
(Barbados) Ltd. His current on the Board of Standards Review of the
American National Standards Institute, The Joint Government Private
Committee of Experts on Electronic Commerce of the FTAA, and the Board
of Trustees of Latin American Young Executives, he has been a member of
the Argentine, Venezuelan and Canadian Delegations to the CITEL
Permanent Consultative Committees I and II (formerly III), and has been a
frequent speaker at industry for a in Latin America and the United States.
John D. R. Craig began his career as a law clerk to Chief Justice Antonio
Lamer and Justice Charles Gonthier of the Supreme Court of Canada in
1994. He joined Heenan Blaikie in 2001 after several years with another
prominent Toronto firm. Mr. Craig practises exclusively in the area of labour
and employment law at the provincial, federal and international levels. He
also provides advice to clients in connection to strategic planning, contract
interpretation and negotiation, pension and benefit administration as well as
labour relations policy. Mr. Craig is an adjunct professor of labour law at the
University of Western Ontario, where he has been teaching since 1999. He is
the author of Privacy & Employment Law (Hart Publishing, 1999), a book
based on his doctoral thesis. He has also published articles related to labour
and employment law in the McGill Law Journal, the Comparative Labour
Law & Policy Journal, the Industrial Law Journal, the Review of
Constitutional Studies, the European Human Rights Law Review and the
Canadian Labour and Employment Law Journal.
Benjamin W. Jeffers has experience in complex business disputes for both
plaintiffs and defendants, at trial and appellate levels of state and federal
courts, as well as other forms of alternative dispute resolution. His practice
focuses on commercial matters and class actions, with a particular emphasis
on automotive OEM/supplier disputes, antitrust and other unfair trade
practice claims, and franchise and distributorship cases. Mr. Jeffers also has
significant expertise with insurance company insolvencies and insurance
guaranty fund laws. He has successfully represented clients in many areas of
xvi
litigation. Mr. Jeffers received both B.A. and J.D. degrees from the
University of Michigan.
Brad D. Cherniak is Co-Founder and Partner of Sapient Capital Partners, a
Toronto-based firm which advises mid-market and early stage companies in
the areas of growth and corporate strategy, acquisitions and divestitures, and
the sourcing of capital. Mr. Cherniak has close to 20 years of experience in
investment research, corporate and investment banking, and merchant
banking and private equity/venture capital with such firms as CIBC Wood
Gundy, Gordon Capital, Bank of America and Chemical Bank. Mr. Cherniak
has long specialized in small – to medium sized, private and early stage
companies, both as advisor and principal. He has also served on a number of
boards of directors and advisory boards of such companies. Mr. Cherniak
graduated Summa Cum Laude from the University of Chicago’s Graduate
School of Business.
Cathy Horton-Panzica, after being educated in High School by the Quakers
at George School in Philadelphia, went on to graduate from the University of
Michigan in 1983, The Ohio State College of Law in 1986 and The
University of Kent Canterbury Theological College in England in 1999. In
2000, she was ordained as an Episcopal priest.
Cathy has spent over 20 years cultivating a global mergers & acquisitions
and venture finance legal practice, serving a myriad of clients that range
from the Fortune 100 companies to emerging and mid-market enterprises.
She spent 15 years in London, where she developed a passion for technology
in the emerging companies’ market place. In Europe, she formed her own
consulting practice and worked with global enterprises and start-ups to foster
and capture the value of strategic technology innovation. Cathy has dedicated
herself to transforming economies through the creation of truly innovative
business strategies using technology. While in London, Cathy served as a
trusted advisor to the Cabinet Office of the Prime Minister, Tony Blair, to
help generate ways in which technology development could drive economic
outcomes for Britain. After her years in London, Cathy recently returned to
her native United States to continue her practice of law and consult with
technology-driven enterprises.
Cathy is the founder and leader of the Red Room Revolution, a set of 20
economic development initiatives structured to transform the Northeast Ohio
Region using a technology platform. She also is a founder of the Beta
Strategy Group and Beta Opportunity Partners Fund which has made a
commitment to fund 24 technology companies in 18-36 months. To date,
Cathy has funded 6 companies and founded 3 of her own. She also
xvii
14
envisioned and started the Beta Technology Park in Mayfield Village, Ohio
which transformed a decaying industrial park into a tech home for early stage
companies to grow using a shared services platform to lower overheads. She
has recently renovated an old barn to headquarter her new business,
Children’s Technology Workshop, which educates second to eighth graders
in creative play using technology. Finally, Cathy is an Associate Priest at
Trinity Cathedral in Cleveland, Ohio.
Dr. Robert D. Hisrich is the Garvin Professor of Global Entrepreneurship
and Director of the Center for Global Entrepreneurship at Thunderbird. In
addition to his M.B.A. and Ph.D. degrees from the University of Cincinnati,
Dr. Hisrich has honorary doctorates from Chuvash State University (Russia)
and the University of Miskolc (Hungary), and held Fulbright Professorships
at the International Management Center in Budapest and the Foundation for
Small Enterprise Economic Development. He has authored or co-authored
fourteen books, including Entrepreneurship: Starting, Developing and
Managing a New Enterprise in its 7th edition and Small Business Solutions:
How to Fix and Prevent the 13 Biggest Problems That Derail Business. Dr.
Hisrich has served on the editorial boards of The Journal of Business
Venturing, Entrepreneurship Theory and Practice, Journal of Small Business
Management, and Journal of International Business and Entrepreneurship.
He has instituted academic and training programs such as an
entrepreneurship training program for high school teachers in Russia and
college level programs at the Institute of International Entrepreneurship and
Management in Russia and the Entrepreneurship Center in the Ukraine.
James Longwell practices in all areas of intellectual property law,
particularly as it applies to computer and information technologies. He
advises start-up companies, small businesses, universities and large
corporations on intellectual property strategy, including acquisition,
protection, exploitation and enforcement issues. Mr. Longwell is also
involved in Canadian and foreign patent and trade mark agency, primarily
preparing and prosecuting patent applications relating to computer software,
hardware, enterprise computing, web development, telecommunications,
medical devices, house wares and business methods. Mr. Longwell also
provides strategic analysis and advice to business owners and investors for
financing, joint ventures, technology procurement, development and
commercialization transactions.
Diane H. Dobrea is a partner in the Columbus office of the law firm Calfee,
Halter & Griswold LLP. She practices in the area of intellectual property
law, with a combined focus on intellectual property transactions, and the
xviii
preparation, prosecution and maintenance of patent and trademark cases.
Though her technical background is in biotechnology, Ms. Dobrea’s patent
practice also includes nanotechnology, chemical, medical device, and
consumer product portfolios. Ms. Dobrea oversees several large patent and
trademark portfolios, working extensively with associates at law firms
around the world on all aspects of intellectual property management. Serving
both for-profit and not-for-profit entities, Ms. Dobrea provides due diligence
and freedom to operate analyses, counsels clients on a wide range of research
and intellectual property related transactions, and assists in litigation and
dispute resolution concerning intellectual property.
Along with her law degree, Ms. Dobrea also received her undergraduate and
masters degrees in Biochemistry from Case. She is a member of numerous
Bar and Intellectual Property Law Associations and the Association of
University Technology Managers, and has been an adjunct professor in
Biotechnology Law and Policy at Case’s Law School. Prior to joining
Calfee, Ms. Dobrea served in the offices of the general counsel and
technology transfer at the Cleveland Clinic and in the technology
management office of Case’s medical school.
Anthony Penhale is a partner and a member of the Business
Development Committee in the Montreal office of Stikeman Elliott and a
member of the Corporate/Commercial Group. His practice is focused
primarily in the areas of securities transactions, corporate finance,
mergers and acquisitions, privatizations and divestitures. Assignments
have included advising a broad range of issuers and underwriters in the
context of public offerings and private placements, counseling issuers in
connection with securities matters, and advising entities in connection
with public market or private acquisitions or divestitures. In addition to
Canada, his work experience includes transactions in the United States,
the United Kingdom and Eastern and Central Europe, particularly
Hungary where he was seconded for a period of six months. Mr. Penhale
is featured in the publication The Best Lawyers in Canada, 2008 edition
in Corporate Law and Securities Law. Mr. Penhale is a member of the
Quebec Bar, of the Canadian Bar Assocation and of the American Bar
Association. In addition, he is a member of the Association for Corporate
Growth.
Elizabeth Dellinger focuses on transactional, capital formation, corporate
and contract work for privately held companies, capital restructuring,
executive contract and strategic business counseling. Her clients include
investment fund portfolio companies, manufacturing, healthcare, aerospace,
insurance, bank and non-bank providers of senior capital and institutional
xix
15
and individual providers of mezzanine and equity capital. Ms. Dellinger
represents clients in capital restructuring and workout transactions, as
counsel to secured lenders, equity stakeholders and corporate constituents.
She is also active in the Negotiated Acquisitions Committee of the American
Bar Association’s Business Law Section.
Hon. Eddie Francis, Mayor of Windsor, Ontario, prior to entering
politics, ran and operated Royal Pita Baking Company. His operation’s
distribution quickly grew to include Ontario and 12 U.S. states. In 2003, he
was awarded the Windsor Chamber of Commerce Business Excellence
Award as the Young Entrepreneur of the Year. Mayor Francis graduated
from the University of Windsor Law School in 2002 and articled with Miller,
Canfield, Paddock, and Stone. Subsequently, Francis was called to the Bar of
the Law Society of Upper Canada. Mayor Francis also holds a combined
Honours Degree in Chemistry and Biochemistry from the University of
Western Ontario.
xx
CANADA-UNITED STATES LAW INSTITUTE CONFERENCE
on
April 13-14, 2007
LIST OF PARTICIPANTS
Jonathan Adler
Stephen DeBoer
Silvana Alzetta-Reali*
Elizabeth Dellinger**
Dr. H. Douglas Barber**
Payal Deora
Mark Bardwell
Diane H. Dobrea**
Mary Lynn Becker
James Doherty
Feleke Bogale
Andrew Dorchak
Craig Brown
Kimberly Eberwine
Rafael Brown
Dean Jonathan Entin
Donald Cameron
Hans Fischer
Chi Carmody
Hon. Eddie Francis**
Brad Cherniak**
Jordane Fura
Cyndee Cherniak
Marty Gelfand
Morton A. Cohen**
Richard Goetz
John Connell**
Gilbert B. Goldberg**
George Costaris
Richard Gordon*
John D. R. Craig**
James Graham
Richard Cunningham*
Jon Groetzinger
William A. Davies**
Mark Hansel
xxi
16
Frank Hartman
Gail Lilley**
Lawrence Herman*
James Longwell**
Dana Hicks
Selma Lussenburg
Dr. Robert Hisrich**
Charles Magerman*
Jerrick Ho
Megan McCarthy
Cathy Horton-Panzica**
Kyle McCoy
Chris Hunter
R. Douglas McCreery
Gordon Jansen
Andrew McIntosh
Benjamin W. Jeffers**
James McIlroy*
Erik Jensen
A. Malachi Mixon, III**
Katharine Johnson
Monty Silley
Charles Kerester
David Morgenthaler**
Asim Khan
Richard Newcomb
Dr. Henry T. King, Jr.*
Sarah Paulett
James Kloos
Anthony Penhale**
Janet Kloos
Steve Petras
Chris Kringel
Samuel R.Petry II
Helen Kryshtalowych
Jullien Philippe
Raymond Ku*
Will Randall
Sophia Lamonde
John Renner
Marilyn Langmack
J. Michael Robinson*
Ronald Lawton
Mark Romoff
Jack Lessenberry
Daniel Sandler*
xxii
Adria Sankovic
Reid Swayze
Michael Scharf
Gerald Torma*
Kelly Schmidt
Deborah Turner
Morris Shanker
Dan Ujczo*
Dean Gary Simson
Catherine Vernon
Michael Spreng
Michael Wager**
Sean Stevens
Susan Wagner
Ron A. Straatsma*
David Woolford**
* Session Moderator
** Session Speaker
xxiii
17
CANADA-UNITED STATES LAW INSTITUTE
ANNUAL CONFERENCE
on
COMPARATIVE LEGAL ASPECTS OF
ENTREPRENEURSHIP IN CANADA AND THE UNITED
STATES
APRIL 13-14, 2007
18
CONFERENCE INTRODUCTION AND WELCOME
Dan Ujczo
&
MR. UJCZO: Good morning. I am Dan Ujczo, the Assistant U.S. Director
of the Canada-United States Law Institute, and it is my great privilege and
pleasure to welcome all of you to the 2007 Canada-United States Law
Institute Annual Conference: Comparative Legal Aspects of
Entrepreneurship in Canada and the United States.
As many of you have been here for five, ten and in several instances we
have people who have been here all 23 years of the Conference, you know
that we run a pretty tight schedule, bell included. So the biographical
information of all of the speakers this morning, as well as the most updated
schedule, is presented in this program – this six by nine that was available at
the registration desk. This is about as up-to-date as we possibly could have it.
It came from the printer last evening.
I think there is one speaker change, which you will be apprised of
tomorrow. Likewise, at the registration desk, there are the Conference
materials – available at the front desk as well. This has background
information for all of the sessions that we are having.
As many of you are aware, this event has been approved by the Supreme
Court of Ohio for 17.5 hours of Continuing Legal Education credit. The
Supreme Court of Ohio is fully electronic right now so the process has
changed a bit; there are no more bubble cards for those of you that are
familiar with that process. The CLE registration desk is outside in the front
as well, and that will be done electronically.
In terms of logistics, for those of you that drove in from Cleveland,
Northeastern Ohio, or elsewhere, parking is available across the street at the
Cleveland Botanical Gardens. Keep your ticket with you at all times and they
will validate you on your way out. That is complementary parking. I know
many of you are staying at the Glidden House. There is also parking
available there for the guests that are staying there.
For those of you that have been with us as in the past, you recognize this
morning is a breach of our customary tradition of opening the event with the
founder of the Canada-United States Law Institute: Sidney Picker. Sidney is
enjoying retirement in beautiful Sanibel, Florida, and he expresses his regrets
for not being here. But he has also resigned from the Board as he is focusing
his energies on training young lawyers and judges in the Russian Federation.
1
19
2
CANADA-UNITED STATES LAW JOURNAL
[Vol. 33 No. 1]
So it is my charge this morning to talk a bit about the Canada-United
States Law Institute and then quickly turn it over to Henry King to introduce
the Conference and our first panelists.
The Institute was created and founded in 1976 by Case Western Reserve
University School of Law and the University of Western Ontario Faculty of
Law. At that time, it was the only program sponsored by two law faculties,
one in Canada, and one in the United States. The innovation of the Institute
at that time was that the two law faculties adopted the curriculum of the other
law school. Even to this day, any course offered at Western is a course
offered at Case and visa versa. We spent all of our money on branding,
becoming Case, and Western spent all of its money becoming Western, and
at the Institute, we are right back to being Case Western.
And what that adoption of the curriculum allows is that our students can
freely transfer and exchange between the two law schools for one semester.
All of their credits and grades transfer back with them as well. Our faculty
freely exchanges between the two law schools; Richard Gordon, who is just
joining us, has just returned from a visit to the University of Western
Ontario.
We also publish the Canada-United States Law Journal, which is
available for all of you outside at the registration table. That’s published
twice yearly. One is the proceedings of this event, the Annual Conference.
Everything is on the record, and it is not uncommon to have calls
immediately after the conference saying could you strike that from the
Journal.
We also publish articles that are submitted by scholars, practitioners
primarily, as well as our students – from students not only from the two law
schools but throughout Canada and the United States that publish scholarly
research – we will publish it in the Journal as well.
The Institute was designed to be an academic program, but from its
earliest days, it sponsored events such as these: conferences for the public
and private bars in each country as well as government officials, industry
leaders, the media and other scholars. Indeed, one of its first conferences was
the first time that a sitting Supreme Court Justice of the Supreme Court of
Canada and Supreme Court of the United States sat on the same panel. It was
the first time in history since 1981 at the Institute.
But the Institute experienced great success in 1983 when Henry King
came not only from his days at the Nuremberg Tribunals but also from TRW
and brought with him his professional and personal experience to the
Institute and launched a three day – at that time two and-a-half day – retreat
type conference: the Annual Conference.
For the past 23 years, it is the predominant forum in Canada-U.S.
relations where, again, government officials, industry leaders,
businesspersons, legal practitioners, scholars, and the media assemble to
Ujczo & King—Conference Introduction and Welcome
3
address the issue of the day. While we focus on law – and we mentioned this
a bit last night because we are a law institute – it allows us to address any of
the myriad of issues confronting the Canada-United States relationship,
whether it be trade, the FTA, NAFTA trade and services, but also the
environment, Great Lakes, the energy and now, certainly in the world in
which we now live, security.
Now, that, in sum, is the Canada-United States Law Institute. We have
launched a number of programs in the past year. Each law school is proud to
have a Canada-U.S. based curriculum. We sponsor student exchange
programs. The University of Western Ontario has, I believe, 17 exchanges
throughout schools in North America. Case Western has programs
throughout the world but also the exchange program between our two law
schools as well as the University of Ottawa, both common and civil law
programs. We, again, publish the Canada-United States Law Journal, and we
host events in Toronto, Washington, Vancouver, and we are looking at
programs in Calgary as well. So you not only have to be in Cleveland, we
will be coming to you and will continue to do so.
Before turning it over to Henry, I know that some of you arrived before
delivery of a box. All of you, beyond the materials I just described in the
Canada-U.S. Law Journal, there is a bag here that has a portfolio and a
Canada-U.S. based pin and our favorite new logo. It is meant to be two sails
by the way. That was the graphic design. I have been learning all about
graphic design in the past year.
So without further ado, I will again welcome you, but I will now turn it
over to the lifeblood of the Canada-United States Law Institute, its U.S.
Director, Henry King.
DR. KING: Thanks, Dan. And I don’t think Dan’s very unusual ability
and special contribution to the work of the Institute should be overlooked.
I am going to begin by opening this conference with a few remarks and
then introduce the program. Canada and the United States share an
entrepreneurial spirit that has rendered our two nations as leaders in the
global economic environment. In order to remain economically competitive
in the years to come, Canada and the United States must continue to cultivate
a society of entrepreneurs.
Throughout this two-day conference, the Canada-United States Law
Institute will bring together leading entrepreneurs, legal experts, government
officials and scholars to explore the current state of entrepreneurship in our
two countries. Panelists will examine entrepreneurial ventures from the
manner in which to structure the venture, securing financing, recruiting and
retaining entrepreneurs, protecting intellectual property, capitalizing on IPOs,
and exploring governmental sources of support. The Conference will also
feature remarks from highly successful entrepreneurs.
20
4
[Vol. 33 No. 1]
As in the past, the Conference proceedings will be published in the
Canada-U.S. Law Journal, the leading academic journal focusing on the
Canada-U.S. legal relationship.
Now I turn to the substance of our program. First of all, we’ll be drawing
the broad strokes in dealing with the relationship of entrepreneurship to
economic growth, job creation, and wealth creation. I will be chairing this
session with David Morgenthaler, who is a founding partner of Morgenthaler
Ventures in Cleveland, Ohio, and H. Douglas Barber, former president and
CEO of Gennum Corporation in Ontario. They will be our speakers.
Our next session will deal with structuring entrepreneurships. We’ll be
dealing with forms of entities, management provisions, and alternative
dispute resolution provisions, et cetera. Here, Gail Lilley of Blake, Cassels &
Graydon in Toronto and Michael Wager of Squire, Sanders & Dempsey in
Cleveland will be our speakers. The session will be chaired by Silvana
Alzetta-Reali, Coca-Cola’s Vice-President and Divisional Counsel in
Toronto.
The luncheon speaker will be A. Malachi Mixon, Chair and CEO of
Invacare Corporation in Elyria, Ohio. He will discuss what it means to be an
entrepreneur. This session will be chaired by Lawrence Herman of Cassels,
Brock & Blackwell in Toronto.
Our early afternoon session will deal with private financing of
entrepreneurships. Our U.S. speaker will be Morton Cohen, Chairman and
CEO of Clarion Capital Corporation of Cleveland and our Canada speaker
will be David Woolford, a partner in Cassels, Brock & Blackwell in Toronto.
Our late afternoon session will deal with government assistance to
entrepreneurship. Here, John Connell of Industry Canada and Gilbert
Goldberg of the Cleveland Office Small Business Administration will be the
speakers. The session will be chaired by Ron Straatsma of Toronto.
Our evening session on the first day of the Conference will be devoted to
a case study of a successful private entrepreneurship. Substituting for Mike
Lazaridis of Blackberry will be Bill Davies of Barbados representing
Blackberry. The session chairman will be Dick Cunningham of Steptoe &
Johnson in Washington, D.C.
The second day of our conference will open up with a few remarks from
Dan Ujczo, Assistant Director of the Canada-U.S. Law Institute. And our
first full session will deal with people aspects of entrepreneurship. Our U.S.
speaker will be Benjamin Jeffers of Dykema Gossett in Detroit and our
Canada speaker will be John Craig of Heenan Blaikie in Toronto. Jerry
Torma of Nordson Corporation of Cleveland will chair this session.
Our second session on day two will deal with the importance of venture
capital in promoting entrepreneurship. Here our U.S. speaker will be Cathy
Bosworth-Horton with the Beta Strategy Group in Cleveland, and our
Canada speaker will be Brad Cherniak of Sapient Capital Partners in
Ujczo & King—Conference Introduction and Welcome
5
Toronto. Professor Daniel Sandler of the University of Western Ontario will
chair this session.
On day two of our conference, Robert Hisrich of Thunderbird School of
Management in Glendale, Arizona will be our speaker, and he will discuss
where the U.S. and Canada stand vis-à-vis other countries regarding
entrepreneurship. James McIlroy will chair this session.
Our early afternoon session on day two will deal with intellectual
property aspects of entrepreneurship. Here Diana Dobrea, a partner with
Calfee, Halter & Griswold in Columbus, Ohio, will be our U.S. speaker, and
our Canada speaker will be James Longwell of Gowling, Lafleur, Henderson
in Toronto. Professor Raymond Ku of Case Western Reserve University will
chair this session.
Our late afternoon session on day two of the Conference will be
capitalizing on the success of entrepreneurship. Elizabeth Dellinger of Baker
& Hostetler in Cleveland will be our U.S. speaker, and Anthony Penhale of
Stikeman Elliott in Montreal will be our Canadian speaker. This session will
be chaired by Professor Richard Gordon of Case Western Reserve
University.
Our final substantive session will deal with entrepreneurship, business
and government. Here the Honorable Eddie Francis, Mayor of Windsor,
Ontario, will be our featured speaker. This session will be chaired by Charles
Magerman of Baker & McKenzie in Toronto.
We shall have a very brief roundup session to end the conference, which
will deal with where we go from here, and I will chair that session.
21
THE IMPORTANCE OF ENTREPRENEURSHIP TO ECONOMIC
GROWTH, JOB CREATION AND WEALTH CREATION
Session Chair – Dr. Henry T. King, Jr.
Canadian Speaker – Dr. H. Douglas Barber
United States Speaker – David T. Morgenthaler
INTRODUCTION
DR. KING: Let’s start our first session. I will call on David Morgenthaler
first. Your remarks I wanted to – you have got all the details on David
Morgenthaler, in his bio, and also my Canadian friend, Douglas Barber – it is
all in the bio data. But I just want to repeat one or two things. He is the
founder of Morgenthaler Ventures, a 39 year-old venture capital mega-fund
with $2.3 billion under management. David has served as director, chairman,
and president of more than 30 companies, and over the last 39 years, he has
developed a national reputation for industry leadership and value added
venture capital investment. I don’t want to take any of your time. I want to
hear what you have to say on our opening subject, David. So the floor is
yours.
7
22
8
[Vol. 33 No. 1]
UNITED STATES SPEAKER
David T. Morgenthaler*
MR. MORGENTHALER: Thank you very much, Henry. It is very nice to
be with you this morning, and thank you for inviting me. Henry assigned me
the topic of the relationship of entrepreneurship to economic growth, job
creation, and wealth. This is a subject that is relevant to me as I phase down
in the venture business.
The formal venture institutional business really started in 1945, right at
the end of World War II.1 I came back out of the service and became an
entrepreneur at that time. So I have been on either side, as both an
entrepreneur financed by venture capital and working with venture
capitalists. And for the last 39 years I moved across the table. I stopped
making an honest living as an entrepreneur and became a venture capitalist.
Question: How does entrepreneurship relate to economic growth, job
creation and wealth? Sadly, the answer is that entrepreneurship is nearly
everything. This was a very hard thing to get our United States Congress to
*
David T. Morgenthaler is the founder of Morgenthaler Ventures, a 39-year-old venture
capital mega fund with $2.3 billion under management. David has served as a Director,
Chairman, or President of more than 30 companies, and over the last 39 years he has built a
national reputation for industry leadership and value-added venture capital investing. He
served from 1977 to 1979 as the President and then Chairman of the National Venture Capital
Association (NVCA). In 1998, he received the first Lifetime Achievement Award by the
NVCA for his work in venture capital and has been inducted into The Private Equity Analysts
Venture Capital Hall of Fame. He received the first Life Time Achievement Award of the IBF
Forum and was named one of the first two Honorary Kauffman Fellows. He was an Advisor to
the Brentwood Associates Funds, a Limited Partner of Hambrecht & Quist, and Vice
Chairman of the Edison Biotechnology Institute. He is serving or has served as a Trustee of
The Cleveland Clinic Foundation, a Member of the Visiting Committee of Carnegie Mellon
University, the Sloan School of The Massachusetts Institute of Technology, the Weatherhead
School of Business at Case Western Reserve University, and a trustee of various philanthropic
organizations. He served as the first Senior Vice President-International for the Young
Presidents’ Organization and as President of the Chief Executives Organization. He is a
member of the President’s Circle of the National Academies of Science and Engineering, and
a member of the Board of Science, Technology and Economic Policy of the National
Academies. From 1957 until 1968, Dave was CEO of Foseco, Inc., manufacturer of specialty
chemicals financed by J.H. Whitney & Co. Earlier in his career, Dave was a member of the
management team of several young growth companies. He received both a BS and a MS
degree in mechanical engineering from the Massachusetts Institute of Technology in 1941.
1
See, e.g., Gerald P. Buccino & Kraig S. McKinley, Turnaround Topics: Is Excess
Liquidity Deferring Business Distress?, 16 AM. BANK. INST. J. 28, 30 (1997); see also Duke
K. Bristow et al., Venture Capital Formation and Access: Lingering Impediments of the
Investment Company Act of 1940, 2004 COLUM. BUS. L. REV. 77, 89 (2004).
Morgenthaler & Barber—The Importance of Entrepreneurship
9
believe back in the early 1970s when we formed the National Venture
Capital Association,2 of which I was very active in the formation, and in
getting a lot of the legislation changed as well as the capital gains tax rolled
back.3 At that time, the view of our leaders in the country, and certainly the
view of our Congress, was that the big companies were nearly everything;
they were where jobs were created, they were where wealth was created, and
the little companies were kind of a nuisance. In a way, when I came out of
graduate school in 1941, that was the attitude at the time. As we dug deeply
into this we finally pointed out this fallacy to Congress and got many of the
changes that were needed made.4 The differences were that the large
companies were not increasing employment.5 In many cases, they were
moving their operations, particularly their manufacturing operations, out of
the older areas, out of the high cost areas, moving them to the lesser cost
areas and subsequently moving them outside of the country.6 It became very
important to understand this phenomenon, and the country was very slow to
understand it.
It is the sad fact that entrepreneurship is nearly everything – and this
bodes badly for the economically mature regions of the country, and even of
the world – because one of the characteristics of a mature region is that
entrepreneurship tends to fall off.7 Now why is this true? And, why is it so
little is understood by the leadership of the successful regions (underscore
successful) when they are at their peaks and have the most resources to do
something about it? Not only do they lose new companies but, more
disturbingly, they show that the regions’ industries are mature.
To understand this, it is necessary to think clearly about some practical,
realistic, and fundamental factors. The first is that economics drive nearly
everything. Go back to the discovery of America. Columbus was an
entrepreneur8 with a very difficult personality9 history tells us – not untypical
2
See About Morgenthaler, http://www.morgenthaler.com/about.asp (last visited Sept. 23,
2007).
3
Id.
4
See, e.g., id.
5
See JUDITH C. BLACKWELL, ET AL., CULTURE OF PREJUDICE ARGUMENTS IN CRITICAL
SOCIAL SCIENCE 128 (Broadview Press 2003) (“[S]mall- to medium-sized businesses still
create far more jobs than do the big transnational corporations operating in the US and
Canada.”).
6
See Ana L. Revenga, Exporting Jobs?: The Impact of Import Competition on
Employment and Wages in U.S. Manufacturing, 107 Q. J. OF ECON. 255, 255-258 (1992)
(discussing the increase in import penetration ratios compared with the fall of U.S.
manufacturing employment during 1975 through 1985).
7
See Linghui Tang & Peter E. Koveos, Venture Entrepreneurship, Innovation
Entrepreneurship, and Economic Growth, 9 J. DEVELOPMENTAL ENTREPRENEURSHIP 161, 163
(2004).
8
Pres. George Bush, Statement for U.S. Department of State Dispatch: North American
23
10
[Vol. 33 No. 1]
of entrepreneurs10 – whose belief that the world was round11 gave him an
opportunity to reach the riches of the Asian markets by sailing West.12
Columbus was almost a prototype entrepreneur.13 Such a person believes that
he sees a business opportunity and a way to fill it, somehow collects the
resources needed, and drives the project through.
The elements listed are like the legs of a stool – omit one, and the stool
collapses. There must really be an opportunity – usually called an existing or
potential market;14 a way to fill it – usually called the product or the service;
the resources needed – usually called the venture capital;15 and the person (or
people) to drive the project to success – usually called the entrepreneur.16
Columbus sought one opportunity but found another: America.17 What led
multitudes to flock to it? It was rich, productive, and free land, when
productive land was wealth.18 Nobody flocked to the Sahara Desert, where
there also was free19 but unproductive land.20 Also, in America there was free
Free Trade Agreement (Aug. 17, 1992) (“Christopher Columbus was an entrepreneur”)
available at http://findarticles.com/p/articles/mi_m1584/is_n33_v3/ai_12686819.
9
See, e.g., Paul E. Hoffman, Book Review: Columbus: The Great Adventure. His Life. His
Times, and His Voyages, 49 WM. & MARY Q., 3d Ser., No. 2, 372 (1992) (“Columbus cannot
remain
friends
with
close
collaborators.”),
available
at
http://www.jstor.org/view/00435597/di976410/97p0091y/0.
10
See BILL BOLTON & JOHN THOMPSON, ENTREPRENEURS: TALENT, TEMPERAMENT,
TECHNIQUE 265 (Elsevier 2004) (“[E]ntrepreneurs are often strongly individualistic and
difficult to work with in groups.”).
11
See generally Valerie I. J. Flint, Columbus, Christopher, http://search.eb.com/eb/article9109621 (describing Columbus and his voyages to North America).
12
Id.
13
See
generally
Entrepreneur,
Oxford
English
Dictionary
Online,
http://dictionary.oed.com (search entrepreneur) (last visited Sept. 23, 2007) [hereinafter
Entrepreneur].
14
See, e.g., Ronald J. Gilson, Engineering a Venture Capital Market: Lessons from the
American Experience, 55 STAN. L. REV. 1067, 1068-1077 (2003); see also Christopher
Gulinello, Engineering a Venture Capital Market and the Effects of Government Control on
Private Ordering: Lessons from the Taiwan Experience, 37 GEO. WASH. INT’L L. REV. 845,
845-850 (2005).
15
See Gilson, supra note 14 at 1070.
16
Id.; see also Entrepreneur, supra note 13.
17
Flint, supra note 11.
18
See, e.g., David C. Korten, The Difference Between Money &Wealth: How out-ofcontrol Speculation is Destroying Real Wealth, http://www.pcdf.org/1999/wealth.htm (last
visited Oct. 5, 2007) (“Real wealth is in. . . fertile land”); see also United States, Encyclopedia
Britannica Online, http://search.eb.com/eb/article-77683 (last visited Sept. 25, 2007)
(discussing the European exploration and settlement of the United States for Commercial
gains) [hereinafter United States].
19
See DAVID PROCHASKA, MAKING ALGERIA FRENCH: COLONIALISM IN BONE, 1870-1920
152 (Cambridge University Press 1990) (“[T]he initial French response [in Algeria] was to
offer prospective French settlers the inducement of free land. But relatively few accepted the
offer”).
11
timber, free furs, and the hope of gold.21 Of course, freedom from religious
and political discrimination,22 desire for adventure, 23 et cetera, also brought
people.24 But, make no mistake – the desire for an economically better life
drove most of it.25
The influx of people provided markets, the flexible and relatively free
society let people exercise their entrepreneurial urges without much restraint,
and the huge country provided the resources.26 The innovation was the
sudden availability of a new, rich, relatively unused continent. In England
and Europe most of the land was already owned and planted.27 Both England
and Europe were, relatively speaking, mature, and innovations were
becoming more technically based,28 such as water-powered mills and later
steam engines.29
20
See C.B. Fawcett, The Extent of the Cultivable Land, 76 THE GEOGRAPHICAL J. 504, 505
(1930) (“[A]rid deserts may at once be written off as uncultivatable”).
21
Exploration and Settlement of The Last Frontier by Europeans and Easterners,
http://www.stumpranchonline.com/skagitjournal/Washington/Gen/Exploration1.html
(last
visited Oct 5, 2007) ( “[The] great interest in the western shores of America [is] because of the
great natural resources of furs, timber, gold”); see generally United States, supra note 18.
22
E.g. An Outline of American History, The Search for Religious and Political Freedom,
http://www.let.rug.nl/~usa/H/1990/ch1_p3.htm (last visited Oct 5, 2007).
23
Sen.
Mike
Crapo,
Profound
Desire
For
Adventure,
http://itd.idaho.gov/transporter/2005/031105_Trans/031105_Crapo.html (last visited Oct 5,
2007) (“[Americans] are the descendants of pioneers whose desire for a better life was mixed
with a spirit of adventure.”).
24
See generally, United States, supra note 18.
25
See Vitor Pinto, Immigration to America: Understanding Immigration Helps Explain
American
People,
http://www.associatedcontent.com/article/206527/immigration_to_america_understanding.ht
ml (last visited Oct 5, 2007) (“[S]ettlers were seeking wealth, land and freedom – a better
life.”).
26
See
generally
Expanding
Markets
and
Moving
West,
www.thomasloveshistory.com/9%20Westward%20Expansion.ppt (last visited Oct. 5, 2007)
(identifying role of markets, entrepreneurial spirit, and land resources in America’s westward
expansion.);
see
also
Virginia,
Encyclopedia
Britannica
Online,
http://search.eb.com/eb/article-77685 (last visited Sept. 25, 2007) (explaining the foundation
of the American colonies, Virginia in particular).
27
See Samuel C. Alessi, The Coming of the Italians to Chautauqua County,
http://freepages.genealogy.rootsweb.com/~cheetah/history.html (last visited Oct 5, 2007)
(explaining how the condition where “there was no land which the landless peasants could
work and produce food. . . prevailed over most of Europe.”).
28
See, e.g., PETER MATHIAS, THE FIRST INDUSTRIAL NATION: THE ECONOMIC HISTORY OF
BRITIAN11700-1914 121 (Routledge 2001) (discussing technical innovations including waterpowered mills and the steam engine.); see also Azizah Y. al-Hibri, The American Corporation
in the Twenty-First Century: Future Forms of Structure and Governance, 31 U. RICH. L. REV.
1399, 1413-1423 (1997).
29
Id.
24
12
[Vol. 33 No. 1]
In the United States and Canada, the innovations to exploit the vast
continental resources continued.30 First came the canals,31 which opened the
rich soils of the Great Plains to the East Coast and even to world markets32
for the grains that could be produced so much better in Ohio and the MidWest than in the flinty soils of New England.33 The result of the canals was
that the cost of shipping a ton of grain from Ohio to New York dropped from
$120 a ton to $6 a ton.34 From New York, cheap ocean transportation35 made
the world markets available and drove the expansion of Midwest farming.36
The innovation of the railroads followed, enabled by the steam engine,37
bringing more flexibility and, thus, tying all regions together.
Note the theme of what I have said so far, that economics drives nearly
everything, and innovations, of some kind – new beliefs, new concepts, new
inventions, new resources, and new ways of doing things – are what
stimulate the economics of a region, a country, or even the world.
Not for nothing were the 1,000 years after the fall of the Roman Empire
called the Dark Ages38 – beliefs became rigid39 and compulsory,40 and new
30
Nathan Rosenberg, American Technology: Imported or Indigenous?, 67 AM. ECONOMIC
REV. 21, 21-22 (“Much of [America’s technological innovation] was specifically geared to the
intensive exploitation of natural resources which existed in considerable abundance relative to
capital and labor.”).
31
See generally Leah M. Green, The Erie Canal and the American Imagination: The Erie
Canal’s Effects on American Legal Development, 1817-1869, 56 ALA. L. REV. 1167 (2005)
(exploring the canal development as a catalyst for economic change and its legal effects).
32
See id.
33
See OH. STATE BD. AGRIC., Sixth Annual Report of the Board of Agriculture of the State
of Ohio for the Year 1851, at 179 (State Printers 1852) (discussing the West’s soil as being
superior to that of New England and the Eastern states).
34
See NOEL M. BURNS, ERIE: THE LAKE THAT SURVIVED, 20 (Rowman & Allanheld
1985) (“[W]hen the Erie Canal was opened eight years later in 1825, the cost of moving
freight from Lake Erie to New York dropped from $120 to $4 per ton.”).
35
See generally Green, supra note 31.
36
See An Outline of American Geography: Regional Landscapes of the United States,
http://guangzhou.usembassy-china.org.cn/uploads/images/wNU1FJhigASwtYYPILXog/An_Outline_of_American_Geography.doc (last visited Oct 5, 2007)
(“[T]he construction of the Erie Canal, and later other canals farther west, made the markets of
the East Coast more accessible to western farmers.”).
37
See Stephen B. Goddard, The Road to Now, 553 ANNALS AM. ACAD. POL. & SOC. SCI.
30 (1997).
38
See Middle Ages, ENCYCLOPEDIA BRITANNICA ONLINE, http://search.eb.com/eb/article9052537 (last visited Sept. 24, 2007) (explaining the period as “a thousand-year period of
darkness and ignorance.”).
39
Id.; see also Robert Freeman, An Entire World Turned Upside Down: The Scientific
Revolution
in
Europe
at
4,
http://www.mvla.k12.ca.us/Projects/694/World_Studies/English_Civil_Wars/Scientific_Revol
ution_GM.pdf (last visited Oct. 5, 2007) (“[A]ll thought was dominated by the rigid religious
orthodoxy”).
40
See Freeman, supra note 39 (stating “Reason was suppressed”).
13
ideas were frozen out.41 People like Galileo and others were confined to
house arrest and punished for offering new ideas.42 It was a time of almost
total lack of innovation.43
But, back to America. The railroads, enabled by the steam engine, tied the
country together cheaply and flexibly.44 Think of what that innovation did!
For the first time in the history of the world, man could travel faster than the
speed of a horse.45
The railroads were quickly followed by a host of lesser but important
innovations – the telegraph, the telephone, electrical lighting to replace
kerosene lighting.46 John D. Rockefeller got rich on kerosene.47 He didn’t get
rich on gasoline; it was the lighting empire that built the Standard Oil
wealth.48 Gasoline in the beginning was a dangerous and unwanted byproduct.49
Other lesser innovations: skyscrapers were enabled by the innovation of
the elevator;50 electrical power came along and replaced the water wheels.51
The reason New England was the center of the wool and manufacturing
industry, the weaving industry, was because it had so many small rivers with
falls in them, so that you could have water powered wheels, which, through a
41
See generally id.
William H. Eddy, Jr., Mind Over Matter: The Coming Revolution in the Natural
Sciences, 45 NAT. RESOURCES J. 521, 523 (2005).
43
See The History Guide Lectures on Ancient and Medieval European History,
Charlemagne
and
the
Carolingian
Renaissance,
http://www.historyguide.org/ancient/lecture20b.html (last visited Oct. 5, 2007) (“There [was]
little or no intellectual pursuit -- no creativity, no innovation in the arts, the learning, no
science.”).
44
See Goddard, supra note 37, at 31-2.
45
Id. (“Before the iron horse, the flesh-and-blood equine had limited how people related to
time and space.”).
46
See
The
Growth
of
Industry,
ENCYCLOPEDIA BRITANNICA ONLINE,
http://search.eb.com/eb/article-77810 (last visited Sept. 24, 2007).
47
See generally Kenneth W. Rose, Rockefeller, John D., AM. NAT. BIO. ONLINE,
http://www.anb.org/articles/10/10-01418.html (last visited Sept 26, 2007).
48
Id.; see also Standard Oil Co. (Indiana), ENCYCLOPEDIA OF CHICAGO,
http://www.encyclopedia.chicagohistory.org/pages/2863.html (last visited Oct. 5, 2007)
(“During these years, the company's main product was kerosene”).
49
See Kenneth E. Boulding, Agricultural Economics in an Evolutionary Perspective, 63
AM. J. AGRIC. ECON. 788, 793 (1981); see also L. M. Gibbs, Gasoline Specifications,
Regulations, and Properties,104 AUTOMOTIVE ENGINEERING, 35 (1996) (“Gasoline . . . was an
undesirable by-product of kerosene manufacturing.”).
50
Jean Gottmann, Why the Skyscraper?, 56 GEOGRAPHICAL REV. 190, 191 (1966) (“The
multistoried building of considerable height was made possible by a remarkable contraption,
the passenger elevator”).
51
See S. SRINIVASAN & C. YANG, FUEL CELLS FROM FUNDAMENTALS TO APPLICATIONS
620 (Springer US 2006) (“[T]he hydraulic turbine replaced the water wheel.”).
42
25
14
[Vol. 33 No. 1]
series of belts and pulleys, opened up the factories.52 These were replaced
originally by steam engines, which meant you could put the factories where
you wanted, and then electrical power gave you more flexibility.53 And there
were countless other lesser innovations that gave mankind benefits which he
needed or he thought he wanted. The mold board plow54 made farming the
fertile but heavy prairie soil practicable.55 The cotton gin made that crop
useful;56 and the list goes on and on. Innovations, innovations, innovations!
That’s the most important word I will use today. And the world has
discovered the concept.
Earlier this week I conferred by video conference with a group from
Singapore who met in our Silicon Valley office. They were told to call on me
by the Singapore Minister of Finance. We manage a large amount of money
for the Singapore government.57 This group, which was from the Singapore
National Research Foundation,58 was put together to coordinate the national
R&D,59 innovation and enterprise efforts of Singapore, and advance its
economy.60 That was stated in their mission.61 They advise the Research,
Innovation, and Enterprise Council,62 chaired by the prime minister
himself.63 Think of our President or the Prime Minister of Canada personally
chairing a research and innovation council! The goal of the group was to
52
See Robert B. Gordon, Cost and Use of Water Power during Industrialization in New
England and Great Britain: A Geological Interpretation, 36 ECON. HIST. REV. 240, 241-42
(1983) (“[The] concentration of many water-power mills in an industrial city was possible in
only those few localities where power canals could be built to distribute water from large
dams, as in the Massachusetts towns”).
53
Id. at 242 (“[S]team power. . . permit[ted] growth above the bounds set by the capacity
of the hydraulic power systems. . . [and] towns could chose between two competing power
sources”).
54
Lowry Nelson, The American Rural Heritage, 1 AM. Q. 225, 227-228 (1949).
55
See id.
56
See generally Paul Finkelman, The Founders of Slavery: Little Ventured, Little Gained,
13 YALE J.L. & HUMAN. 413, 419 (2001); see also History of Cotton,
http://www.cotton.org/pubs/cottoncounts/story/index.cfm (last visited Oct 5, 2007) (“[T]he
cotton gin in the U.S. paved the way for the important place cotton holds in the world today. . .
[because it] could do the work 10 times faster than by hand.”).
57
See Press Release, Walden International, Why Your US Venture Capitalist is Not
Calling You (Feb. 16, 2001), http://www.wiig.com/main/news_035.htm (“The Government of
Singapore Investment Corp (GIC) and Temasek Holdings are among investors in
Morgenthaler's funds.”).
58
See generally National Research Foundation, http://www.nrf.gov.sg/ (last visited Oct. 6,
2007).
59
National Research Foundation, http://www.nrf.gov.sg/ (follow “About Us” hyperlink;
then follow “Our Establishment” hyperlink) (last visited Sept. 26, 2007).
60
Id.
61
Id.
62
Id.
63
Id.
15
understand more of the enterprise eco-system in the U.S., to try to learn what
makes the U.S. innovation system so successful, and to try to identify further
growth areas for their future programs.64
Next week I am chairing a conference in Washington put on by the
Science, Technology and Economics Board of the National Academies,65
which consist of the National Academy of Science, the National Academy of
Engineering, and the Institute of Medicine.66 This is a free conference to
advise public policy makers67 and held at one of the National Academy’s
buildings in Washington.68 You are all welcome to attend. The purpose of
this conference is to sum up a study we have been doing on Global
Innovation Systems, to help U.S. government policy makers ascertain where
the U.S. stands, compared to the rest of the world.69 We are financed partly
by Congress,70 and we are running several conferences71 to sum up a good
deal of the work we have done.72 We have studied about a dozen of the most
important sectors of the U.S. economy73 and will report briefly on all of
these, and in more detail on information technology, life sciences, and
financial services.74
The preliminary reports I am getting worry me. Why? I fear too many of
our industry sectors are too complacent. While I don’t expect the bottom to
fall out over the next several years, the long-term outlook is sobering. Why?
Let’s go back in history a bit.
Sixty-six years ago I got my master’s degree from MIT. Three years
before we were scared we would not be able to get jobs because of World
64
See generally id.
See THE NATIONAL ACADEMIES, Globalization of Innovation: Emerging Trends in IT,
Biopharma,
and
Finance
Conference,
http://www.nationalacademies.org/gateway/pga/3765.html (last visited Sept. 25, 2007).
66
The National Academies, http://www.nationalacademies.org (follow “About the
National Academies” hyperlink) (last visited Sept. 26, 2007) (“Four organizations comprise
the Academies: the National Academy of Sciences, the National Academy of Engineering, the
Institute of Medicine and the National Research Council.”).
67
See generally THE NATIONAL ACADEMIES, supra note 65.
68
See id.
69
See Board on Science, Technology, and Economic Policy, The National Academies,
http://www7.nationalacademies.org/step/Globalization%20of%20Innovation.%20April%2020
07%20Meeting.html (last visited Oct. 5, 2007).
70
See
Organization
of
the
National
Academies,
http://www.nationalacademies.org/about/faq1.html (last visited Oct. 6, 2007) (“The federal
government funds about 85 percent of the institution's work.”).
71
See THE NATIONAL ACADEMIES, supra note 65.
72
Id.; see also Board on Science, supra note 69.
73
Board on Science, supra note 69 (“[The] Board has commissioned papers on 11
industries ranging from semiconductors to biotechnology to venture capital.”).
74
Id. (“They are concentrated in 3 sectors -- information technology (software as well as
hardware), life sciences-based industries, and financial services.”).
65
26
16
[Vol. 33 No. 1]
War II. Luckily, the demand had picked up and engineers were hot
property.75 At that time, the automobile was the economic driver of the U.S.
economy,76 and the hot jobs were in Detroit,77 Cleveland, 78 Pittsburgh,79 and
the other cities now called the Rust Belt.80 The semi-conductor had not been
invented, 81 so the Electronic Age had not started. 82 Boston was a backwash
for jobs.83 The Silicon Valley, Austin, and the Research Triangle did not
exist.84 Shortly, I went off to war as a Captain of Engineers throughout the
African and Italian campaign. When the war was over, I joined a group of
people starting a company in Erie, Pennsylvania, and became what we today
would call a serial entrepreneurial manager,85 helping to build up several
very small companies. Today we seek serial entrepreneurial managers.
Today, we seek such people to start companies for us. In those days it was
thought people like me couldn’t hold a job. Things change.
75
Robert P. Morgan, et. al., The Changing Nature of Engineering, ASEE PRISM (1998),
available at http://findarticles.com/p/articles/mi_qa3797/is_199805/ai_n8803619 (“After
World War II, several factors, including the beginning of the Cold War and a postwar
economic boom, heightened U.S. demand for engineers and led to large increases in the
numbers of practicing engineers, engineering students, and engineering fields and subfields.”).
76
See Jenny Nolan, Willow Run and the Arsenal of Democracy, DET. NEWS, Jan. 28, 1997,
available at http://info.detnews.com/history/story/index.cfm?id=73&category=locations.
77
See id.
78
See, e.g., Janet H. Cho, The Homefront, CLEV. PLAIN DEALER, Sept. 5, 2005, at E1
(explaining “Cleveland’s booming wartime factories.”).
79
PHILIP JENKINS, PENNSYLVANIA: A HISTORY OF THE COMMONWEALTH, Ch. 7 (Randall M.
Miller
&
William
Pencak
eds.,
2002)
available
at
http://www.psupress.psu.edu/Justataste/samplechapters/pennsylvania/Chapter_7.pdf.
80
Id.
81
See Joe Simnacher & Crayton Harrison, Jack Kilby: 1923-2005: Longtime TI Engineer's
Semiconductor Paved The Way For Computer Revolution, DALLAS MORNING NEWS, Jun. 21,
2005, available at http://www.metroplextbc.org/news_20050621_kilby.html (explaining the
“invention of the semiconductor chip in 1958.”).
82
See
Guy
Ball,
The
Birth
of
the
Electronic
Age,
http://www.vintagecalculators.com/html/the_birth_of_the_electronic_ag.html (last visited Oct.
2, 2007).
83
See Geoff Lewis et. al., History of Boston’s Economy, Growth and Transition 1970AUTH.
(1999),
available
at
1998,
B.
REDEVELOPMENT
www.cityofboston.gov/bra/PDF/ResearchPublications//pdr529.pdf.
84
See Mylene Mangalindan & Dave Mayfield, Is Virginia Next Silicon State?, VIRGINIANPILOT, Sept. 3, 1995, at D1, available at http://scholar.lib.vt.edu/VA-news/VAPilot/issues/1995/vp950903/09020360.htm (“[The Research Triangle started 30 years ago.”);
see generally TIMOTHY J. STURGEON, UNDERSTANDING SILICON VALLEY: ANATOMY OF
ENTREPRENEURIAL REGION 1, Ch. 1 (Martin Kenney ed, Stanford University Press, 2000).
85
See generally Dan Bricklin, Natural Born Entrepreneur-Lessons of a Serial
REV.,
No.
8
(2001),
available
at
Entrepreneur,
79
Harv.
BUS.
http://hbswk.hbs.edu/archive/2569.html.
17
Institutional venture capital came into being right after the war.86 In late
1945, Jock Whitney started J. H. Whitney & Company with $10 million of
family money in New York.87 Today venture firms spill that much money.88
About that same time, Karl Compton, president of MIT, and Senator Ralph
Flanders felt the need for a fund to finance the early stage technology89
coming out of research in radar and vacuum tube electronics.90 Remember
that was before the semiconductor.91 They wanted to back new ideas and
finance young engineering people, and hired General George Doriot, a
professor at the Harvard Business School to run it. These were the two
original institutional venture capitalists.92
Whitney, looking for managers with entrepreneurial backgrounds, found
me in 1950, and we had a 7-year courtship, involving several of their
companies. I finally took the presidency of the fourth one in 1957 – the
American licensee of a very small British multi-national, which we
ultimately built into 57 corporations, manufacturing in 22 countries and
warehousing and selling in about 75 countries.
Prior to 1945, venture capital had primarily come from wealthy families,
corporations, and banks that made higher risk loans.93 It had a very long
history, of course. Sea voyages were financed by wealthy merchants who
shared in the profits of the cargo, if the ship got back.94 Fortunes were made
by firms like the East India Company;95 but, there were charlatans as well.96
When I left school, I thought an entrepreneur was a French swindler. After
39 years as a venture capitalist, I’ve learned they’re not all French.
Legend has it that Queen Isabella pawned her jewels to finance
Columbus’ voyages.97 When U.S. Steel became public, a number of Andrew
86
Duke K. Bristow & Lee R. Petillon, Public Venture Capital Funds: New Relief from the
Investment Company Act of 1940, 18 ANN. REV. BANKING L. 393, 404 (1999).
87
Id.
88
See, e.g., id.
89
Id. at n. 69 (explaining how they founded AR&D).
90
See Hans Landström, Research on Institutional Venture Capital: The Past, The Present,
The Future, LUND U. INST. OF ECON. RESEARCH, at 6-7, available at
http://www.snee.org/filer/papers/414.pdf.
91
See Simnacher, supra note 81.
92
Bristow, supra note 86, at 404.
93
Id. at n. 66.
94
See, e.g., Charlie Cray & Lee Drutman, Corporations and the Public Purpose Restoring
the Balance, 4 SEA. J. SOC. JUST. 305, 309 (2005).
95
Id.
96
See, e.g., Om Prakash, The Transformation from a Pre-Colonial to a Colonial Order:
The Case of India, 22 (Jan. 1, 2005) (unpublished manuscript on file with The London School
of
Economics
and
Political
Science)
available
at
http://www.lse.ac.uk/collections/economicHistory/GEHN/GEHN%20PDF/Transformation%2
0from%20a%20Pre-Colonial%20-%20Om%20Prakash.pdf.
97
Bristow, supra note 86, at 404 n. 66.
27
18
[Vol. 33 No. 1]
Carnegie’s partners became millionaires,98 and Pittsburgh, for a time, became
the venture capital center of the country.99 Today, such people are called
“Angel Investors.”100
A few more facts about venture capital:
• There are about 700,000 new businesses started each year in
the U.S., according to tax returns, including all the small 1- or
2-person service businesses. 101 Of those, a majority do not
last 5 years.102
• Professional venture capital funds, like ours, finance only
about 1,000 of these, or 1 in 700.103 The number is not very
precise, but whether it is 1 in 500 or 1 in 1,000 is not very
important, we don’t finance many.104
• The importance of venture capital institutions is that they
finance most of the high growth, exciting companies that get
started.
A few numbers about the industry:
• A large firm, like us, will see more than 1,000 business plans
a year.105
98
See generally Mark Skousen, This Icon of Capitalism Had The Answers,
http://www.mskousen.com/Books/Articles/0201icon.html (last visited Oct. 2, 2007)
(explaining how one of Carnegie’s first acts after U.S. Steel went public was to create a $5
million pension plan); see also Walter Adams & James W. Brock, The New Learning and the
Euthanasia of Anti-Trust, 74 Cal. L. Rev. 1515, 1553 n. 171 (1986) (explaining how U.S.
Steel was formed into “the nation’s first billion dollar corporation.”).
99
John Cook, Venture Capital: The Steel City bends into Seattle Mold, SEA. POSTINTELLIGENCER,
Feb.
3,
2006,
available
at
http://seattlepi.nwsource.com/venture/258150_vc03.html (“[Pittsburgh] has a history of
entrepreneurialism. . . it helped shape the industries of the late 19th century.”).
100
Guy Kawaski, Who Exactly are Angel Investors?, INC. MAGAZINE, Dec. 2000, available
at http://www.inc.com/articles/2000/12/21310.html (stating angel investors are “high networth individuals who invest in entrepreneurial companies”).
101
Barnaby J. Feder, EARNING IT; Good Product. Sound Plans. No Sure Thing., N.Y.
Jan.
18,
1998,
available
at
TIMES,
http://query.nytimes.com/gst/fullpage.html?res=9400EED71738F93BA25752C0A96E958260
(quoting “There are 600,000 to 700,000 new businesses created each year”); see also Karen E.
Klein, What’s Behind High Small-Biz Failure Rates?, BUS. WEEK, Sept. 30, 1999, available at
http://www.businessweek.com/smallbiz/news/coladvice/ask/sa990930.htm.
102
See id.; Tim Berry, Planning, Startups, Stories: 20 Million Bootstrappers,
http://blog.timberry.com/2007/07/20-million-boot.html (last visited Oct. 2, 2007) (“[A]bout
700,000 new businesses start each year, and 550,000 close.”).
103
Angel Investing and Entrepreneurship, http://www.thinkinglike.com/Essays/angelinvesting.htm (last visited Oct. 2, 2007) (“[O]nly one or two new companies in a thousand
ever receives venture capital from professional venture capital firms.”).
104
Id.
105
JOHN L. NESHEIM, HIGH TECH START UP, REVISED AND UPDATED: THE COMPLETE
HANDBOOK FOR CREATING SUCCESSFUL NEW HIGH TECH COMPANIES, Dust Jacket (The Free
•
•
•
19
Five years later – on national statistics – we will wish we had
never seen 996 of the 1,000. Why? Because we will not invest
in 990,106 so we wasted our time. Of the 10 we did invest in,
we will lose all our money in 3, plus more money we put in
hoping to save the first money.107 On another 3 we will make
so little it was not worth the time and risk.108 That is the 996
we wished we could have avoided.
Three we will make a good return on,109 and one will be a big
winner, a gorilla, if we are lucky. It is these few big winners
that keep us in the early-stage venture business.
Private equity, the highly leveraged110 purchase of mature
businesses,111 is a totally different activity.112 Losses are much
fewer.113 The debt is the big risk,114 and huge winners are
extremely rare. 115 At the moment, this is highly popular and is
Press 2000) (“A typical venture capital (VC) firm reviews 1,000 high tech business plans a
year; it funds about six of them.”).
106
See generally Angel Investing, supra note 103; see also MinorityFinance.com,
http://www.minorityfinance.com/vc.html (“A VC firm may see 1,000 business plans in a year,
and only fund 10.”).
107
See Klein, supra note 101 (“30% lose money.”).
108
See id. (“30% break even.”).
109
See generally id. (“39% are profitable.”).
110
Steve Rosenbush, Private Equity’s Big Debt Burden, BUS. WEEK, May 29, 2007,
available
at
http://www.businessweek.com/bwdaily/dnflash/content/may2007/db20070529_241277.htm
(“[F]irms [are] borrowing once unimaginable sums to pay for their record deals.”); see also
Ron Wilson, Semiconductor Companies, Advanced Processes and Private Equity: It All Fits
Together,
EDN,
Jul.
25,
2007,
http://www.edn.com/index.asp?layout=blog&blog_id=1690000169&blog_post_id=12000123
20 (describing “private equity in its pursuit of maximum leverage”).
111
See MPs Want Private Equity Tax Probe, BBC NEWS, Jul. 29, 2007 available at
http://news.bbc.co.uk/1/hi/business/6919576.stm (commenting on the “increase in the number
of highly-leveraged private equity-owned firms.”); see generally GERALD T. LINS ET AL.,
HEDGE FUNDS AND OTHER PRIVATE FUNDS: REGULATION AND COMPLIANCE, ch. 12 pt. I
(Thomson West 2006).
112
LINS, supra note 111 (“[T]he nature of the investment process [for private equity]
usually differs substantially from that of a hedge fund and other investment vehicles.”).
113
See generally id.
114
Jason Kelly, Private Equity Moguls Feeling the Pinch, BUS. REPORT, Oct. 2, 2007,
available
at
http://www.busrep.co.za/index.php?fSectionId=&fArticleId=4060473
(commenting on “the risky debt that private equity firms rely on to fund acquisitions.”).
115
See John V. Duca & Mine K. Yücel, Exploring the Economics of Biotechnology: An
RES.
BANK
OF
DALLAS
(2002),
Overview
at
7,
FED.
http://www.dallasfed.org/research/pubs/science/intro.pdf (“[M]ost venture firms directly
invest in young companies, without intermediaries. The distribution of returns is highly
skewed, with few big winners.”).
28
20
[Vol. 33 No. 1]
almost certainly being overdone.116
I wish I could say that venture capital institutions are the most important
thing in regional economic development, but it simply isn’t true. When Ohio
became great in the late 1800s and early 1900s,117 there were no institutional
venture capitalists.118 Silicon Valley took off when Bill Shockley took the
semiconductor there in 1957,119 and there were no institutional venture
capitalists in that region either.120 I looked at that region in 1949 and I found
it was a lovely place to live, but I could pick fruit or raise vegetables for a
living there.121 There was relatively no high technology.122 Fred Terman at
Stanford was trying to get Bill Hewlett and people like that going, but they
were very small.123
Silicon Valley was driven by the semiconductor.124 Bill Shockley was
financed by Arnold Beckman out of Los Angeles,125 and they had a fight
about whether or not it went to San Francisco or Los Angeles (where Arnold
wanted to put it,) but Bill Shockley’s mother lived in Palo Alto, and that’s
where he went.126 He hired the so-called “traitorous 8”127 – great men like
116
See LINS, supra note 111 (“[A] growing number of financial institutions engage in
private equity or merchant banking activities by establishing or investing in private equity
funds.”).
117
See generally George W. Knepper, Ohio’s Historic Properties, OH. HISTORICAL SOC.,
Ch. 3, available at www.ohiohistory.org/resource/histpres/docs/ThePlanCh3.pdf.
118
Bristow, supra note 86.
119
TIMOTHY J. STURGEON, UNDERSTANDING SILICON VALLEY: ANATOMY OF AN
ENTREPRENEURIAL REGION, Ch. 1 (Martin Kenney, ed. Stanford University Press 2000)
available at http://ipc-lis.mit.edu/globalization/Silicon%20Valley.pdf at 1.
120
See generally id.
121
Erin E. Dooley, Silicon Valley Toxics Coalition, 110 ENVTL. HEALTH PERSPECTIVE 4
(2002), available at http://www.ehponline.org/docs/2002/110-4/forum.html#ehpnet (“Silicon
Valley was once an agricultural landscape covered in fruit orchards”).
122
See id.; see also Where is Silicon Valley and How did it get its Name?,
http://www.brighternaming.com/Silicon_Valley_name.html (last visited Oct. 5, 2007)
(“Before Silicon Valley got its moniker, it used to be a luscious fruit valley.”).
123
Bill Hewlett, The Human Side of Management, 3 SMECC VINTAGE ELECTRICS 1,
available at http://www.smecc.org/the_human_side_of_management_-_bill_hewlett.htm
(Hewlett admitting “we were very small and insignificant.”).
124
Interview,
Sanford
Robertson
(1997),
http://www.businessweek.com/1997/34/trans34/robertso.htm (finding Silicon Valley’s
“technology was fueled by the semiconductor industry.”).
125
The
Time
100,
Scientists
and
Thinkers,
TIME
MAGAZINE,
http://www.time.com/time/time100/scientist/profile/shockley03.html (last visited Oct. 6,
2007).
126
See MANUEL CASTELLS & PETER HALL, TECHNOPOLES OF THE WORLD: THE MAKING OF
TWENTY-FIRST-CENTURY INDUSTRIAL COMPLEXES 16 (Routledge 1994) (“[Shockley] moved to
Palo Alto – because, among other reasons, his aged mother lived there.”).
127
The Traitorous Eight Traitorously Leave Shockley Semiconductor, PBS,
http://www.pbs.org/transistor/album1/eight/index.html (last visited Oct. 28, 2007).
21
Bob Noyce128 and Gordon Moore129 – and two years later they spun out to
form Fairchild Semiconductor. 130 They were financed by Sherman Fairchild
out of New York.131 His family had done early investing in IBM.132 Most of
the semiconductor firms then spun out of Fairchild,133 including especially
Intel.134 So, venture capital does not cause innovation, it follows it –
anywhere and everywhere it thinks there is a business opportunity and a way
to fill it.
The automobile at the end of the 19th Century and in the early years of the
th
20 Century was the greatest innovation the country had ever seen.135 It
brought along the steel industry, tires, machine tools, glass, road building,
gasoline, and a host of service industries, including insurance, finance, repair
shops, etc.136 The Rust Belt cities became rich on these mechanical
industries137 and rode them for far too long. They almost entirely missed the
semiconductor industry,138 which became the real driver of the economy after
128
See Robert Noyce, Encyclopedia Britannica, http://www.britannica.com/eb/article214871/Robert-Noyce (last visited Oct. 5, 2007).
129
See
generally
Gordon
Moore,
PBS,
http://www.pbs.org/transistor/album1/moore/index.html (last visited Oct 6, 2007).
130
Fairchild Semiconductor, Answers.com, http://www.answers.com/topic/fairchildsemiconductor-international?cat=biz-fin (last visited Sept. 24, 2007).
131
Id.
132
Sherman M. Fairchild, Sherman Fairchild Library of Engineering and Applied Science,
http://library.caltech.edu/sherman/fairchild.htm (last visited Sept. 24, 2007).
133
See TIMOTHY J. STURGEON, UNDERSTANDING SILICON VALLEY: ANATOMY OF AN
ENTREPRENEURIAL REGION Ch. 1, How Silicon Valley Came to Be at 1 (Martin Kenney ed.,
Stanford University Press, 2000) (“The spin-off of Fairchild Semiconductor from Shockley
Transistor and the ‘Fairchildren’ that followed are widely believed to be the stimuli that set the
Silicon Valley juggernaut in motion.”).
134
Fairchild
Semiconductor,
PBS,
http://www.pbs.org/transistor/background1/corgs/fairchild.html (last visited Oct. 25, 2007).
135
See
Randal
O’Toole,
America’s
Greatest
Invention,
http://www.i2i.org/main/article.php?article_id=1317 (last visited Oct. 6, 2007) (explaining
why “the automobile may be the greatest invention of the past 230 years.”); see generally
History
of
American
Automobile,
Eastern
Connecticut
University,
http://www.easternct.edu/depts/edu/units/automobile.html (last visited Sept. 25, 2007)
(discussing the innovation of the automobile).
136
See JAMES E. MCCLELLAN & HAROLD DORN, SCIENCE AND TECHNOLOGY IN WORLD
HISTORY: AN INTRODUCTION 342 (JHU Press 2006) (explaining how the “automobile industry
fostered technical innovations” and subsidiary work in steel, glass, rubber, gasoline, roads,
etc.).
137
See Rust Belt, http://www.answers.com/topic/rust-belt?cat=biz-fin (last visited Oct. 6,
2007) (“The phrase [rust belt] became synonymous with industrial decline in the oncedominant U.S. [cities with] heavy manufacturing and steel industries.”); see generally
Pennsylvania:
Emergence
of the Modern State, Encyclopedia Britannica,
http://www.britannica.com/eb/article-78296/ (last visited Sept. 25 2007).
138
See, e.g., John Markoff, Gould to Be Acquired By Nippon Mining, N. Y. TIMES, Aug 31,
1988,
available
at
29
22
[Vol. 33 No. 1]
1960,139 enabling a huge number of other innovations.140 The leadership of
the Rust Belt cities did not realize they were missing the future, leading to
the decline in their manufacturing jobs today.141
What is the future? We are all trying to guess what will be the new, new
thing. What are the innovations that entrepreneurs will be pushing to create
new jobs and new wealth? Is it nanotechnology – a technology looking for a
market?142 Is it alternative fuel – a huge market looking for economically
viable technology?143 Is it fuel cells? Is it some other new material, as yet
undiscovered? Is it new medicines or medical devices – ones that will slow
aging or cure major diseases? Or is it something no one has thought of yet?
Will our space explorations bring back something that will change our lives
in some important way? Or, will a huge number of new jobs be created in
trying to stop global warming?
Nobody knows for sure. What we do feel is that the important new
innovations will come out of technology144 – most of the simple stuff has
already been invented, and very few of us are likely to go to our basement
workshops or out to our barns and come up with inventions that will change
our lives and create thousands of jobs.
http://query.nytimes.com/gst/fullpage.html?res=940DE6DA133AF932A0575BC0A96E94826
0 (distinguishing between “a traditional Rust Belt manufacturer [and] a high-technology
computer, semiconductor” business).
139
See
Economy,
Semiconductor
Industry
Association,
http://www.siaonline.org/iss_economy.cfm (last visited Oct. 6, 2007) (“[T]he semiconductor sets the pace of
global economic growth.”).
140
See generally Thierry Weil, Why and How European Companies Reach out to Silicon
Valley, INSTITUT FRANÇAIS DES RELATIONS INTERNATIONALES, available at THE NEW
AMERICAN CHALLENGE: CORPORATE STRATEGIES AND EUROPEAN POLICIES 16 (IFRI 2000),
also available at http://www.ifri.org/files/Notes_Ifri/Notes_25_Weill.pdf (“[A]ccounts of
Silicon Valley tell the impressive story of an area built on the numerous refinements and
applications of semiconductors”).
141
See
Geography:
USA,
Chapter
7
–
The
Midwest
Heartland,
http://www.geog.nau.edu/courses/alew/ggr346/text/chapters/ch7.html (last visited Oct. 6,
2007) (citing “The decline in manufacturing jobs in the cities surrounding the Great Lakes”).
142
See JOHN L. NESHEIM, THE POWER OF UNFAIR ADVANATGE: HOW TO CREATE IT, BUILD
IT, AND USE IT TO MAXIMUM EFFECT 164 (Simon and Schuster) (describing how many believe
nanotechnology is “a technology looking for a market”); see generally, Ernie Hood,
Nanotechnology: Looking As We Leap, 112 no. 13 ENVTL. HEALTH PERSPECTIVES (2004),
available at http://www.ehponline.org/members/2004/112-13/focus.html.
143
See, e.g., Ethanol Industry Needs Technology, People: Scientist, CBC NEWS, July 5,
2006,
available
at
http://www.cbc.ca/canada/manitoba/story/2006/07/05/ethanolresearcher.html.
144
See Tom Stevens, High-Tech, High-Touch Paradox, BUS. LEADER MAGAZINE, Sept.
2004,
http://www.businessleadermagazine.com/index.aspx?page=articles.sep04.sep04_hightouch
(“Technology creates innovation”).
23
The most advanced countries, like the U.S., Canada, and Europe, have a
concern. Back in the 1950s I spent a great deal of business time in Britain.
We had long discussions on business development and when Britain’s
problems were pointed out, the answer – with a superior air – was, “Oh,
Britain will always muddle through.”145 We know it didn’t146 and Japan
became the world’s second largest economy.147 Today, when this discussion
is held in the U.S., all too often the answer comes back, “Yes, but Yankee
ingenuity will save us.”148
In a world where most of the innovations are likely to be the products of
complicated applied research and expensive semiconductor type fabrication
plants,149 the number of engineers and scientists China and India are training
is really frightening.150
Am I too alarmist? Maybe. But, to quote the great Intel CEO, Andy
Grove, “In the competitive world of today, only the paranoid survive.”151
DR. KING: That was excellent. We will have questions after our other
speakers.
We have a man well known to many of you. He was here last year, and
we welcome him back this year. His name is Douglas Barber. He is from
McMaster University in Canada.152 He has held about every office you can
145
See generally Marina Hyde, Britain Thrives in Adversity and Non-Combatant
Jul.
3,
2007,
Strawberries,
GUARDIAN,
http://blogs.guardian.co.uk/sport/2007/07/03/britain_thrives_in_adversity_a.html (referencing
the use of “the phrase ‘muddle through.’”).
146
DONLEY T. STUDLAR, GREAT BRITAIN: DECLINE OR RENEWAL 26 (Westview Press 1996)
(analyzing the “British economic decline, [a] relative economic decline to be sure”).
147
U.S.
DEPT.
OF
COMMERCE,
U.S.
Commercial
Service:
Japan,
http://www.buyusa.gov/japan/en/mom.html (last visited Sept. 25, 2007).
148
See generally, e.g., Dale Brown, How to Help the Disabled Pay Their Own Way;
Oct.
3,
1989,
available
at
Ingenuity
Will
Prevail,
N.
Y.
TIMES,
http://query.nytimes.com/gst/fullpage.html?res=950DE2D6143DF930A35753C1A96F948260
(giving “opinion that American ingenuity will prevail”); see also Shelly K. Wong, A Shining
Example
of
Yankee
Ingenuity,
PROVIDENCE
J.,
Apr.
8,
2007,
http://www.projo.com/travel/getaways/TRV-GETAWAY-CONN-MINE_04-0807_CC2257E.f0f19d.html.
149
See generally Patrick J. Buchanan, Death of Manufacturing, AM. CONSERVATIVE, Aug.
1, 2003, available at, http://www.amconmag.com/08_11_03/cover.html.
150
See Sheila Reily, U.S. Holds Own Vs. China, India Engineer Grads,
http://www.informationweek.com/outsourcing/showArticle.jhtml?articleID=188501208 (last
visited Sept. 27, 2007) (finding 137,437 engineering graduates for the U.S. compared to
112,000 for India and 351,537 for China.)
151
Andrew
S.
Grove,
Only
The
Paranoid
Survive:
Book
Preface,
http://www.intel.com/pressroom/kits/bios/grove/paranoid.htm (last visited Sept. 27, 2007)
(declaring “I’m often credited with the motto, ‘Only the paranoid survive.’”).
152
Ontario Research and Innovation Council Biography of Douglas H. Barber,
http://www.mri.gov.on.ca/ORIC/english/bios/HDouglasBarber.asp (last visited Oct. 13, 2007)
[hereinafter Barber Biography] (“He is also continuing an academic career as a distinguished
30
24
[Vol. 33 No. 1]
hold at McMaster, and they are listed in the bio data,153 so I will not read
them. He is also the founder of Gennum Corporation,154 which designs,
manufactures, and markets microcircuits.155 At present, it employs over 600
people.156 He was president and CEO until his retirement in 2000, and he has
continued until recently as a director.157 So it is a great pleasure and honor to
professor-in-residence at McMaster University”).
153
See id. (“He formerly chaired and is currently a member of McMaster's board of
governors.”).
154
Id. (“Dr. Douglas Barber is one of the founders of Gennum Corporation.”).
155
Gennum
Corporation,
CHIPDOCS,
http://www.chipdocs.com/manufacturers/GENUM.html (last visited Oct 28, 2007) (“Gennum
Corporation is a Canadian high technology company which designs, manufactures and
markets electronic components, primarily silicon integrated circuits (IC's) and thick-film
hybrid circuits, for specialized applications.”).
156
See generally Gennum Corporate Profile, http://www.gennum.com/about/index.php (last
visited Oct. 13, 2007) (“[Gennum e]mploys over 400 people worldwide”).
157
Barber Biography, supra note 152.
*
H. Douglas Barber, born on a Saskatchewan farm, attended the University of
Saskatchewan obtaining his B.Sc. with Great Distinction, the Governor General’s Gold Medal
and a M.Sc. in Electrical Engineering. As an Athlone Fellow and NATO Scholar he received
his Ph.D. from Imperial College, University of London in 1965. Dr. Barber began employment
at Canadian Westinghouse, Hamilton, Ontario, Canada. In 1973 he was one of the founders of
Linear Technology Inc., now known as Gennum Corporation, which designs, manufactures
and markets microcircuits. Gennum has grown profitably at 20% per year and now employs
about 650 people. Dr. Barber was President and CEO when he retired in 2000. He continues as
a Director. He was a part-time Engineering Physics Professor at McMaster University from
1968 to 1994. In 2001 he was appointed Distinguished Professor-in-Residence. Dr. Barber
authored 29 papers and several patents. He speaks frequently on business, technology,
learning, innovation and economic development. Dr. Barber was actively involved in
Microelectronics initiatives in Canada including the Canadian Semiconductor Technology
Conference, the Canadian Microelectronics Corporation, the Sectoral Skills Council, the
Canadian Semiconductor Design Association, Micronet and the Strategic Semiconductor
Consortium. Dr. Barber’s honors include the APEO Engineering Medal, the University of
Saskatchewan C.J. Mackenzie Distinguished Graduate Award, the Professional Engineers of
Ontario Gold Medal, and Engineer of the Year Award of the Hamilton Engineering Institute.
Dr. Barber has received an Honorary Doctorate of Engineering from the University of
Waterloo, an Honorary Doctorate of Science from McMaster University, and in 1999 was
named Ontario’s Technology Entrepreneur of the Year, receiving the National Citation for
Innovation & Technology. This year Dr. Barber was appointed as an Officer of the Order of
Canada. He was a Director of the Strategic Microelectronics Consortium, the Canadian
Advanced Technology Association, the Hearing Industries Association and the Alberta
Microelectronics Corp. He was a member of the Sectoral Skills Council, the Natural Sciences
and Engineering Research Council of Canada, the National Innovation Strategy, the Ontario
Postsecondary Education Quality Assessment Board and Vice Chair of the Ontario Science
and Innovation Council. He was a founding co- chair of the National Information Technology
Initiative that sponsored eMPOWR Canada Inc. in 2001, and is a past director of the Golden
Horseshoe Venture Forum. He is a member of the Electrochemical Society, the Institute of
Electrical and Electronic Engineers, the Hamilton Civic Coalition and the Burlington Post
Secondary Task Force. At McMaster University, Dr. Barber is a member of the Board of
25
present Douglas Barber, again here, for this conference, and we look forward
to what you have to say.
CANADIAN SPEAKER
Dr. H. Douglas Barber*
DR. BARBER: Thank you, Henry. And thank you, David, for really
painting an impressive picture that really gives a great base for me to launch
out on something that may be a little bit more academic. I may even wade
into the world of law, which I know almost nothing about; what I have
learned from a few fights in the courts is that legal fights can be very, very
expensive!
Because I am in an academic institution these days, I can take a little bit
more academic approach to things. Economic growth, wealth, and job
creation come from specialization and trade.158 Self-sufficiency, which is the
opposite of specialization, has real limits, both in terms of what one person
can do and what they have to do it with.159
I grew up on a pioneer farm in Saskatchewan, a province in Canada
immediately north of Montana and North Dakota, where it gets cold in the
winter and hot in the summer.160 It was in the depression and drought of the
1930s.161 Farms were less specialized then than they were in the 1920s
Governors, the Senate and the Directors College. He is Chair of the Engineering Dean’s
Advisory Board. He is a Director of Micralyne Inc., NetAccess Systems Inc., DALSA
Corporation, and AllerGen NCE Inc. He is a member of the Conference Board of Canada
Leader’s Roundtable on Commercialization, the Ontario Ministry of Economic Development
and Trade’s Commercialization Advisory Council, the Institute of Quantum Computing and
the Ontario Research and Innovation Council. Dr. Barber and his wife, June, have raised a
family of four whose families now include eight grandchildren. He is a man of faith with over
30 years of active involvement in their church.
158
USAID Guidebook: Foreign Aid in the National Interest, Ch. 2 Driving Economic
Growth (2003), available at http://www.usaid.gov/fani/ch02/newthinking.htm (“Economists
have conceptualized the process of economic growth around three basic models: specialization
and trade, investment in machines, and increasing returns to knowledge.”).
159
See generally, Pedestrians Guide to the Economy, http://www.amosweb.com/cgibin/awb_nav.pl?s=pdg&c=dsp&k=24 (last visited, Oct. 13, 2007) (giving why an economy
should forgo self sufficiency in favor of trade specialization).
160
See The Weather Channel Monthly Averages for Saskatoon, Canada,
http://www.weather.com/outlook/travel/businesstraveler/wxclimatology/monthly/graph/CAX
X0442?from=search (last visited Oct. 15, 2007).
161
See
1930s
Drought,
CBC
News
Online,
In
Depth:
Agriculture,
http://www.cbc.ca/news/background/agriculture/drought1930s.html (last visited Oct. 15,
2007) (discussing Canada in the 1930s and stating “1930 was the start of a 10-year
period of drought”).
31
26
[Vol. 33 No. 1]
because farmers in those conditions had little to trade.162 They had to do
everything they could for themselves to survive.
I learned that moving from self-sufficiency to more specialization is a
move towards prosperity.163 Prosperity is not an outcome of doing everything
yourself. So you specialize to produce things of value for others, who have
also specialized because they can’t do everything for themselves either.164 It
is success in that choice of specialization and trade that changes the
economy, creates wealth, and engages more people in specialized
enterprises.165
To grow, you either have to create more value or expand your area of
trade. Sustainable wealth and job creation must do both of those all the
time.166 You can see this at play in the developed world. Large economies
like the United States can be more self-sufficient and very prosperous while
trading less than ten percent of their economy outside of the nation.167
There is a lot of trade within the nation.168 Canada and the other 11 or 12
countries that are above us today in the wealth of nations typically trade
between 35 and 45 percent of our economies to prosper.169 Each one has to
162
See generally id.
Supra note 159 (“Specialization makes us a lot better off than self-sufficiency.”).
164
See id. (“[A]s a general rule, that each of us specializes in producing some stuff then
exchanging for other.”).
165
See generally id. (“When everyone in the economy specializes, we have a larger
economic pie which (depending on how it's divided) can make everyone better off.”); see also,
e.g., A Life Science Strategy for Saskatchewan, SUCCESS Spring 2007, Ag-West Bio Inc.,
available at http://www.agwest.sk.ca/publications/success/SUCCESS%20Spring%2007web.pdf (“[A] small workforce makes it important for Saskatchewan to focus on a few priority
areas to ensure a competitive advantage.”).
166
See generally James K. Jackson, Trade Agreements: Impact on US Economy, CRS
Report
RL31932,
at
9
n.17
(2007),
available
at
http://italy.usembassy.gov/pdf/other/RL31932.pdf (“By specializing in the production of those
goods and services in which it is most efficient, or in which it has a comparative advantage, a
nation maximizes its total productive capability and national income.”).
167
See generally Ben Wattenberg, Get Over It, Folks, JEWISH WORLD REV., Sept. 3, 1998,
available at http://www.jewishworldreview.com/cols/wattenberg090398.html (“Imports and
exports made up 10 percent of the economy in 1954.”).
168
See generally Christopher Sands, Canada’s Problem: Domestic Trade Barriers, THE
AMERICAN, May 22, 2007, available at http://www.american.com/archive/2007/may0507/canada2019s-problem-domestic-trade-barriers (article compares and contrasts
differences between U.S. and Canadian domestic trade).
169
See
generally
Trade
as
a
Percentage
of
GDP,
http://wps.aw.com/aw_krgmnobstf_interecon_7/0,10540,2078562-content,00.html (last visited
Oct. 29, 2007) (follow “Data” hyperlink); see also Michael Spence, The Economy: Engines of
Growth,
WALL
ST.
J.,
Jan.
23-24,
2007,
available
at
http://www.hoover.org/publications/digest/8093682.html (speaking generally about the factors
that make economies successful).
163
27
focus on areas of value creation for the world where they can do that
competitively.170
Of course, they trade in order to buy the things that they don’t make and
that they can’t do competitively for themselves.171 They generally work to
live within their means. That means that their balance of trade, exports minus
imports,172 should be quite small. It is typically less than one percent of their
GDP173 and, to be sustainable, it needs to be positive over time.174
Over the last 30 years, most of those 11 or 12 countries that are today
doing better than Canada have grown their economies and moved ahead of
Canada in the prosperity of nations as we have slipped in that ranking.175
Jobs in these prospering developed countries are typically about 75 percent in
the services sector, about 20 percent in the goods production sector, and
about five percent in primary industries.176 They don’t vary much on that.
170
See generally Spence, supra note 169; see also OECD, Moving Up the Value Chain:
Staying Competitive in the Global Economy (Main Findings, 2007), available at
http://www.oecd.org/dataoecd/24/35/38558080.pdf; see, e.g., Why do Countries Trade? The
Advantages
of
International
Trade,
TUTOR2U,
http://www.tutor2u.net/economics/content/topics/trade/free_trade.htm (last visited Oct. 29,
2007) (“Japan can produce camcorders at lower costs - its supply curve is lower than the UK.
This means that Japan has a comparative advantage in producing camcorders.”).
171
See Why do Countries Trade?, supra note 170 (“Britain needs to export goods and
services to finance imports of those products we cannot produce in this country.”); see
generally Spence, supra note 169 (discussing principals of sustaining economic growth).
172
The Central Bank of the Republic of Armenia, Yerevan 10 V. Sargsyan 6, 53-54,
available at http://www.cba.am/publications/prog/annex.pdf (explaining “balance of trade
(written as imports minus exports)” and “balance of trade, or the proportion by which imports
can exceed exports”).
173
See
generally
U.S.
Balance
of
Trade,
TRADING
ECONOMICS,
http://www.tradingeconomics.com/Economics/Balance-of-Trade.aspx?Symbol=USD
(last
visited Oct. 26, 2007) (follow “compare with” hyperlinks); see also The Library of Economics
and
Liberty,
Balance
of
Trade
and
Balance
of
Payments,
http://www.econlib.org/LIBRARY/Topics/HighSchool/BalanceofTradeandBalanceofPayment
s.html (last visited Oct. 13, 2007) (defining the concept of balance of trade).
174
See Gabor Steingart, America and the Dollar Illusion, SPIEGEL ONLINE, Oct. 25, 2006,
available at http://www.spiegel.de/international/0,1518,440054,00.html (explaining how a
negative balance of trade could produce a crisis); see also Balance of Trade and Balance of
Payments, supra note 173 (infers that balance of trade would have to be sustained to have an
impact).
175
Heather Scoffield, Canada’s Slipping on the World Stage, THE GLOBE &MAIL,
Sept.
27,
2006,
available
at
http://www.competeprosper.ca/index.php/about/in_the_news/canadas_slipping_on_the_world
_stage_wef_study_shows_switzerland_tops_compet/.
176
See Steve Lohr, Academia Dissects the Service Sector, but Is It a Science?, N.Y. TIMES,
Apr.
18,
2006,
available
at
http://www.nytimes.com/2006/04/18/business/18services.html?ex=1145678400&en=4175e91
33eddcb40&ei=5087 (discussing the importance of the service sector which “now employ
more than 75 percent of American workers”).
32
28
[Vol. 33 No. 1]
In countries with a small work force, prosperity depends on being able to
export in all of those areas. However, because most exports come from the
goods producing enterprises that don’t employ many people,177 all of these
countries have the challenge to act strategically. It is very easy to believe that
your internal services are the basis of your economy and to not be
sufficiently strategic about trade.
There is always competition. Trade is a value exchange. To sustain trade
in the face of aggressive competition it is necessary to create better value at
lower cost. That’s the nature of productivity.178 Productivity always has to be
a concern in regard to prosperity.179 Trade barriers are introduced to protect
home enterprises.180 These are acts of power, defense, and mistrust that
impact the value exchange. I am going to talk more about that later.
However, it remains true that economic growth, wealth, and job creation
comes from specialization and trade – the value exchange.181
Now, let’s consider the economy. The economy is the system through
which we get our needs, and perhaps, some of our wants met.182 Wants that
get met regularly for some time do tend to evolve into needs.183 So prosperity
is always somewhat elusive.184
177
See generally Congressional Budget Office, Economic and Budget Issue Brief, What
Accounts for the Decline in Manufacturing Employment?, Feb. 18, 2004, available at
http://www.cbo.gov/ftpdoc.cfm?index=5078&type=0.
178
See Jim Pinto, Cheaper, Better, Faster – The Productivity Race,
http://www.automation.com/sitepages/pid1939.php (last visited Oct. 16, 2007).
179
Productivity and Prosperity Project, ARIZ. ST. U., http://www.asu.edu/president/p3/ (last
visited Oct. 27, 2007) (“Enhancing productivity is the primary means of raising prosperity.”).
180
David
P.
Bianco,
Trade
Barriers,
http://www.referenceforbusiness.com/encyclopedia/Thir-Val/Trade-Barriers.html (last visited
Oct. 15, 2007) (stating the protection of domestic producers is a reason for trade barriers).
181
Jaime
Ros,
Trade
Specialization
and
Economic
Growth,
IDRC,
http://www.idrc.ca/fr/ev-93559-201-1-DO_TOPIC.html#enh1 (last visited Oct. 29, 2007)
(analyzing how trade specialization can affect long-term economic growth performance); see
also Pinto, supra note 178.
182
See,
Dr.
Donald
Schunk,
Ask
an
Economist,
hhttp://www.sces.org/LMI/data/trends/economist/quest2.asp (lat visited Oct. 13, 2007) (“[L]et
us think about what an economy is. In any economic system, there must be a way for
resources to be put to use to produce goods and services.”); see also ELLIOT ETTENBERG, THE
NEXT ECONOMY (2001) (explaining the economy driven by customer wants).
183
ETTENBERG, supra note 182; Kevin Sims, Needs Must, SALVATION ARMY, Apr. 1, 2004,
http://www1.salvationarmy.org/ihq%5Cwww_sa.nsf/vwissue/2FD585720C4FD03380256EDC007FBF42?opendocument&id=46FE538284C7F60980
256EDC007F2F6B (“[W]ants turn into needs.”).
184
Ralph Massey, Speech to the Nassau City Rotary: Prosperity, The Elusive Goal, Oct. 7,
2002, available at http://www.nassauinstitute.org/wmview.php?ArtID=337 (discussing the
difficulty in achieving national economic success and stating “prosperity is so elusive”).
29
The value exchange is a very human process, and I want to emphasize
that.185 I remember well the expression of Peter Drucker, who said at one
point in his long life, “You know, in my whole life I have never seen a
market place a purchase order.”186 Guess what? Purchase orders are actually
very human things. When you are getting one or giving one, it is people
facing each other that determine whether that happens or not.187
The value exchange is a very human process.188 Both what is valuable is
determined by people, and their choices determine whether the exchange will
occur or not.189 What is valued is what people need or want on any level –
physical, emotional, psychological, or spiritual.190 Economic activity can
occur on all of those levels.191
In the value exchange, there is always a competitive drive to provide
value in a better way and to win the value away from other suppliers in the
exchange. That is the nature of any business. We are actually all in a value
exchange if we are getting paid.
This creates a continuous dynamic in commerce. There are always
opportunities, both to offer better value and to offer new value. These are
opportunities that can generate economic growth, wealth, and job creation.
There are enterprises that arise to take those opportunities and there are those
that disappear in this dynamic. It is the entrepreneurs that keep this dynamic
moving.
In Canada, with a work force of 17 million people,192 we have about 1
million business enterprises of all kinds193 that employ about 13 and-a-half
185
Stakeholder
Value,
CSR
QUEST,
http://www.csrquest.net/default.aspx?articleID=13347&heading=The%204CR%20Framework
(last visited Oct. 28, 2007) (discussing “the human process of value creation”).
186
H. D. Barber, Speech at The BEDC Mayor’s Luncheon: Succeeding in the Global
Economy
–
A
Canadian
Perspective,
Sept.
8,
2005,
available
at
http://www.careeradvancement.on.ca/news_detail.aspx?page_id=0&news_id=17.
187
See generally, e.g., Institute for Business Integrity, Wright St. U., Private Sector
Consulting Firm Ethics Case Analysis and Proposed Resolution, available at
http://www.wright.edu/rscob/ibi/ibi_consulting_firm_ethics_sample_analysis_and_resolution.
doc (case study discussing ethics in client sales transactions).
188
Stakeholder Value, supra note 185; see also Charles Hall, Cutler J. Cleveland & Robert
Kaufmann, Use and Exchange Value, http://www.eoearth.org/article/Value_theory (last
visited Oct. 14, 2007) (discussing the development of various competing theories of value
exchange and how those theories are based on societal values).
189
Hall, supra note 188 (“In a general sense an entity. . . has value if it can be exchanged
for another good. . . and/or if it is in some way deemed useful or important by its possessor.”).
190
See id. (“[V]alue assumes that individual and societal tastes, preferences, and economic
decisions are influenced and often directed by environmental factors . . .”).
191
See generally id.
192
Statistics Canada, Labour Force Characteristics, Unadjusted, By Province (Monthly),
http://www40.statcan.ca/l01/cst01/lfss02a.htm (last visited Oct. 18, 2007) (Sept. 2007 Canada
Labour Force: 17.9 million).
33
30
[Vol. 33 No. 1]
million of those 17 million workers.194 The public sector employs the
remainder.195 The public sector employees are funded from treasuries and,
therefore, are somewhat isolated from the value exchange, and that can create
misunderstandings. In the business enterprises, the dynamic is clearer. About
13 percent disappear every year,196 and that includes one percent that
disappear because they go bankrupt.197 So there are 12 percent that disappear
for a whole variety of other reasons.198 However, every year in Canada about
14 percent appear as new enterprises on the scene, giving rise to about a one
percent per year growth in the enterprises of Canada.199 Enterprises with less
than 100 employees account for over 40 percent of the employment in
Canada.200 This dynamic and this churn require a lot of entrepreneurial skill
to support it.
The churn does raise a good question: Couldn’t we improve the success
rate and decrease the amount of energy and talent needed in the churn? It is
worthwhile here to ask another question: What is an entrepreneur? It is a
word rooted in the French word entreprendre, which means to undertake.201
193
Sri Kanagarajah, Business Dynamics in Canada, STATISTICS CANADA,
http://www.statcan.ca/english/freepub/61-534-XIE/61-534-XIE2006001.htm (last visited Oct
26, 2007) (“[T]here were just over one million businesses in Canada in 2003.”); see also
Canadian Industry Statistics, Establishments Canadian Economy, INDUSTRY CANADA,
http://strategis.ic.gc.ca/sc_ecnmy/sio/ciseste.html (last visited Oct. 15, 2007) (estimating less
than 1.1 million Canadian employer establishments).
194
See generally id.; see also Public Sector Statistics, STATISTICS CANADA,
http://www.statcan.ca/english/freepub/68-213-XIE/2006000/t005_en.htm (last visited Oct. 25,
2007).
195
See generally id.
196
See
generally
Canadian
Market
Research
Made Fast and Easy, GDSOURCING, http://www.gdsourcing.com/gdstart.htm (last visited Oct
22, 2007); see also Key Small Business Statistics: How long do small businesses survive?,
INDUSTRY CANADA, Apr. 2004, http://www.ic.gc.ca/epic/site/sbrp-rppe.nsf/en/rd00865e.html;
Moya
K.
Mason,
Small
Businesses,
nts.
1,
7,
14,
http://www.moyak.com/researcher/resume/papers/businesses2.html (last visited Oct. 15, 2007)
(discussing the average number Canadian businesses that start and fail annually).
197
But see Mason, supra note 196 (“[A]bout 145,000 new businesses start up each year in
this country, and about 137,000 businesses declare bankruptcy each year.”).
198
See generally id. (discussing reasons businesses fail in many industrialized nations).
199
See generally id.
200
Industry Canada, Small Business Quarterly, Vol. 5, No. 2, Aug. 2003, available at
http://www.ic.gc.ca/epic/site/sbrprppe.nsf/vwapj/3367_SBQ_eng.pdf/$FILE/3367_SBQ_eng.pdf (describing small businesses
creating 39% of net new jobs in Canada).
201
See Enterprise, WEBSTER’S NEW INTERNATIONAL DICTIONARY 853 (2nd ed. 1959)
(“[E]nterprise from the French entreprendre, meaning. . . an important undertaking”); see also
Jeff Bailey, Can You Teach Someone How To Grow a Business?, WALL STREET J. ONLINE,
available at http://www.collegejournal.com/mbacenter/newstrends/20030819-bailey.html (last
visited Oct 29, 2007) (“The word entrepreneur [Webster's: from French entreprendre, to
undertake: one who organizes, manages and assumes the risks of a business or enterprise]”).
31
In fact, enterprise is a word from the same root.202 An entrepreneur then is
one who initiates and undertakes a commercial enterprise.203 That is a value
exchange enterprise with all the associated organizational management and
financial challenges and risks. A successful entrepreneur can’t be weak in
relation to any of those challenges.
The Entrepreneur of the Year Program204 defines the entrepreneur as one
who: firstly, undertakes a new business venture, as the founder of a
business;205 secondly, takes great risk, both personal and on behalf of
others;206 thirdly, succeeds in the business but may have failed a number of
times before;207 fourthly, demonstrates innovation,208 where innovation is
competitively meeting needs and desires in the value exchange;209 fifthly, is a
deliberate and capable planner;210 and sixthly, manages people effectively;211
and seventhly, leads and establishes an effective culture and values and gives
direction and vision.212 That’s quite a list, but that’s the one used to select the
entrepreneur of the year.213
DR. KING: Which you were.
DR. BARBER: I was the Technology Entrepreneur of the Year, in
Canada.214
202
Id.
See Jeff Bailey, supra note 201.
204
Celebrating Entrepreneurial Achievement: Entrepreneur of the Year Awards, ERNST &
http://www.ey.com/global/content.nsf/US/EGCS_YOUNG,
_Entrepreneur_of_the_Year_Awards_-_Overview (last visited October 16, 2007).
205
Entrepreneur
of
the
Year
Nominations,
ERNST
&
YOUNG,
http://www.ey.com/GLOBAL/content.nsf/Canada/Entrepreneur_Of_The_Year__Awards_Process_-_Nominations (last visited Oct. 19, 2007).
206
See generally Entrepreneur of the Year Award: Recognizing the Best, ERNST & YOUNG,
http://www.ey.com/GLOBAL/content.nsf/Canada/Entrepreneur_Of_The_Year__Awards_Process_-_Post-Nominations (last visited Oct. 19, 2007).
207
See generally id. (“Entrepreneurial Spirit/Corporate Culture: The nominee demonstrates
perseverance in the face of adversity and overcoming obstacles, learns from experience,
fosters teamwork and builds loyalty.”).
208
Id. (“Innovation: What new approaches or technologies have been implemented? What
investment has been made in R&D? How well does the nominee adapt to change and develop
products/services ahead of the market?”).
209
See generally Innovation, WEBSTER’S NEW INTERNATIONAL DICTIONARY 1282 (2nd ed.
1959) (stating it is the “introduction of something new”).
210
See generally supra note 206 (“Strategic Direction/Market Position/Industry Impact”).
211
See generally id. (“The nominee has earned respect from staff, competitors and advisers,
is a strong communicator, influences others”).
212
See generally id. (“Personal Integrity/Influence”).
213
Id. (answering “What do the judges look for?”).
214
Entrepreneur of the Year Award: Regional Award Recipients 1999, ERNST & YOUNG,
http://www.ey.com/global/Content.nsf/Canada/Entrepreneur_Of_The_Year_-_Recipients__Regional_-_1999 (last visited Oct. 19, 2007).
203
34
32
[Vol. 33 No. 1]
Clearly, the commercial competitive dynamic requires high quality
entrepreneurs to collectively achieve the success that fuels economic growth,
wealth, and job creation. There are several important factors that are
determinates of sustainable success for these entrepreneurs.
The first is the scope of trade in their entrepreneurial vision. There are
many enterprises obviously that operate very locally, and they do create
wealth and prosperity, but that limits their scope for growth and increases
substantially the risk that competition from outside their locality will wipe
them out. For many enterprises, the customer world must be aggressively
global.215
The second factor is the motivation or the purpose for the enterprise. It
can be simply to make the entrepreneurs wealthy, and there probably has to
be some aspect of that in the entrepreneurial drive, but that’s not a
sustainable enterprise if that is the vision or the motivation. A sustainable
enterprise must focus on creating value for all its stakeholders and especially
for its customers.
The book “Built to Last”216 describes 18 visionary companies,217 who
today average about $75 billion in revenues218 with 175 thousand employees
each.219 They are, on average, just about 100 years old. 220 The only common
elements the book found amongst them was that they all had highly
articulated purposes and values,221 where cultivating and sustaining these was
a very important aspect of the leadership.222
215
Cf. Anne Gaw & Steve Liu, Corporate Entrepreneurship: Beyond Two Guys in a
MARSHALL,
available
at
Garage
4,
Fall
2004,
U.
S.
CAL.
http://www.marshall.usc.edu/media/pressroom/pdf_short/STRAT_CorpEntrepreneur.pdf
(stating Johnson and Johnson and 3M “have built a competitive advantage by focusing on
innovation and the ability to develop products and services in a broad market scope.”); see
generally, e.g., CRM Today, ClientLogic Bolsters Global Customer Care Outsourcing
Leadership
during
2004,
Jan.
12,
2005,
http://www.crm2day.com/news/crm/EEpVVEAuyArOuSfRlq.php (customer care industry
outsourcer discusses strategy: “we continued to aggressively execute our global business
strategy-expanding our right-shore service options and developing new processes that help our
clients reduce their operating costs and improve the overall customer experience”).
216
JAMES C. COLLINS & JERRY I. PORRAS, BUILT TO LAST: SUCCESSFUL HABITS OF
VISIONARY COMPANIES (HARPER BUSINESS 2002) (1994).
217
See id. at 3 (listing the companies studied as 3M, American Express, Boeing, Citicorp,
Ford, General Electric, Hewlett-Packard, IBM, Johnson & Johnson, Marriott, Merck,
Motorola, Nordstrom, Philip Morris, Proctor and Gamble, Sony, Wal-Mart, & Walt Disney).
218
See generally id.
219
See generally id.
220
Id. at 13 (“The companies in our study averaged ninety-two years of age, with an
average founding date of 1897.”).
221
Id. at 54 (“In nearly all cases, we found evidence of a core ideology that existed not
merely as words but as a vital shaping force.”).
222
Id.
33
These 18 companies223 have gone through five generations of people.224
They are all in different businesses today, but they are all successful.225 That
says something. A successful enterprise has many different value exchanges
occurring together, and all must be integrated for success. We have
considered some of them.
The third factor is that innovation and continuous improvement are
essential to sustainability. The competitors who are actively seeking a way to
win away your customers or your employees or your shareholders are always
present. That is a significant driver of the enterprise dynamic. Sustainable
enterprises must be continually renewing and reinventing themselves,226 and
that requires entrepreneurial people.
The fourth factor is that successful entrepreneurs need broad learning.
That is true even though the enterprise has to specialize. It is not sufficient
just to know what you are going to do and how you are going to do it. Those
are largely product or service and technology issues. The successful
entrepreneur must also know who will do it and whom it will be done for. In
the end, the commercial enterprise is a very human enterprise. It takes
wisdom to succeed. Successful entrepreneurs have often gained wisdom
through experience, perhaps in a good business or perhaps through their own
failures.
Are entrepreneurs born or are they made? I always say the answer is yes.
They are born and made.227 There is opportunity to develop them better and
sooner. They are significant shapers of our future. Commerce is a very
human activity.228 The value exchange occurs best where there is trust and
freedom.229
223
COLLINS, supra note 216.
See id. at 13 (“The youngest companies in our study were founded in 1945”).
225
See id. at 24-27 (confronting the misconception that successful companies start out with
a great idea, where Merck started merely as an importer of chemicals, 3M started as a failed
corundum mine, and Boeing’s first airplane failed, stating, “In all, only three of the visionary
companies began life with the benefit of a specific, innovative, and highly successful initial
product or service.”).
226
See id. at 187 (“Visionary companies install powerful mechanisms to create discomfort
– to obliterate complacency – and thereby stimulate change and improvement before the
external world demands it.”).
227
Entrepreneurs Are Both Born and Made, BUS. WEEK ONLINE, Oct. 10, 2000,
http://www.businessweek.com/smallbiz/content/oct2000/sb20001010_202.htm
(interview
with Bob Baum, professor of new program at University of Maryland, stating “I think that
entrepreneurs are both born and made.”).
228
Cf. Theodore W. Schultz, The Value of the Ability to Deal with Disequilibria, 13 J.
ECON. LITERATURE 827, 827 (Sept. 1975) (“Behavior of human beings is governed by the
criterion of optimization under constraints that are specific to circumstances confronting each
person”).
229
Stephen Knack & Paul J. Zak, Building Trust: Public Policy, Interpersonal Trust, and
Economic Development, 10 S. CT. ECON. REV. 91, 92 (2002) (“[I]f trust is sufficiently low, so
224
35
34
[Vol. 33 No. 1]
We know free trade is good,230 but not all humans, human organizations,
communities, or countries can be trusted to be honest and ethical.231 While
entrepreneurs who can create value competitively are essential to economic
growth, wealth, and job creation, they are not all honest and ethical.232
Philosophically, we interpret self-interest to be the best driver of
competition and value creation.233 Now, that’s a belief that can easily be
associated with free enterprise and private enterprise and words like that,
which are roots for us.234 While self-interest is part of ethical behavior, it can
become the principal driver of unethical behavior.235
Ethics is about acting for the good of all who are affected by the act,
including the entrepreneur.236 All human activities are affected by the ethical
tone and spirit present in the people. The challenge for each of us is how do
little investment will be undertaken that economic growth is unachievable,” and that
“interpersonal trust is a powerful economic stimulant”); see also Frank L. Jefferies & Richard
Reed, Trust and Adaptation in Relational Contracting, 25 ACAD. MGMT. REV. 873, 879 (Oct.
2000) (“When there is high-affect based trust in the form of a belief that his or her opposites
are concerned for the negotiator’s well-being, there is a freedom to quickly share information
and ideas.”).
230
MILTON FRIEDMAN & ROSE D. FRIEDMAN, FREE TO CHOOSE: A PERSONAL STATEMENT
(HARCOURT
BRACE
JOVANOVICH
1980)
available
at
http://www.hoover.org/publications/digest/3550727.html (adapted from “The Tyranny of
Controls”) (“Ever since Adam Smith there has been virtual unanimity among economists,
whatever their ideological position on other issues, that international free trade is in the best
interests of trading countries and of the world.”).
231
See Kurt Eichenwald, In Enron Case, a Verdict on an Era, N.Y. TIMES, May 26, 2006,
available at http://www.nytimes.com/2006/05/26/business/businessspecial3/26verdict.html;
Laurie Goodstein & Stephanie Strom, Embezzlement is Found in Many Catholic Dioceses,
N.Y. TIMES , Jan. 5, 2007, available at http://www.nytimes.com/2007/01/05/us/05church.html.
232
E.g. Eichenwald, supra note 231.
233
Frederick C. Hicks, Competition as a Basis of Economic Theory, 10 PUBLIC ATIONS AM.
ECON. ASS’N 82, 83 (Mar. 1895) (“Competition and combination, representing equally normal
manifestations of self-interest, are equally necessary to economic science.”).
234
See William D. Grampp, What Did Smith Mean by the Invisible Hand?, 108 J. POL.
ECON. 441, 455 (Jun. 2002) (discussing Smith’s “invisible hand” theory, stating “The riches of
the nation, then, are the product of self-conscious, self-interested effort,” and “The merchant,
when in competition with others, will place his capital where it adds most to the nation’s
wealth, and he does not have to be told where that is.”).
235
See James C. Wimbush & Jon M. Shepard, Toward an Understanding of Ethical
Climate: Its Relationship to Ethical Behavior and Supervisory Influence, 13 J. BUS. ETHICS
637, 641 (1994), reprinted in Lynne L. Dallas, A Preliminary Inquiry Into the Responsibility
of Corporations and Their Officers and Directors for Corporate Climate: The Psychology of
Enron’s Demise, 35 RUTGERS L. J. 1, 29-30 (Fall 2003) (“This [unethical behavior] is
expected to occur because only in an ethical climate based on an egoistic decision-making
criterion would persons most likely act in ways to promote their own exclusive self-interest
regardless of law, rules, or the impact their decisions have on others.”).
236
See John Cottingham, The Ethics of Self-Concern, ETHICS 101, 798, 812 (July 1991)
(“For Aristotle, ethics is about the good, or the good for man, or the “supreme good.”).
35
we know what is good? And how do we act for the good of others and
ourselves? That’s a tough question.
Economic growth, good jobs, and wealth creation describes a situation of
prosperity.237 Prosperity is present where people thrive. People thrive where
they are productive, healthy, and committed to the good of their
community.238 Prosperity means that their needs on all levels – physical,
emotional, psychological, and spiritual – are being abundantly met.239 It
means people are balanced in their lives, and safe and confident in their
environments.240
My reading of history and my experience of successful enterprise have
convinced me that prosperity and ethical behavior are very strongly linked,
certainly sustainable prosperity requires that.241 Those 18 companies
described in “Built to Last” have cultivated this kind of milieu.242 Visit their
websites;243 you will sense that there is a difference about them.
237
See generally Stephen L. Carter, A Symposium Commemorating the Bicentennial of the
United States Constitution: The Constitution, the Uniqueness Puzzle, and the Economic
Conditions of Democracy, 56 GEO. WASH. L. REV. 136, 140 (Nov. 1987) (“The Theory of
Democratic Prosperity explains the success of constitutional government in the United States
by pointing to the growth over time of the economy, the generally improving standard of
living, the existence of independent economic power as counterweight to government, and the
continued flourishing of the middle class.”).
238
See generally William Damon, What is Positive Youth Development?, 591 ANNALS AM.
ACAD. POL. & SOC. SCI. 202, 207 (Christopher Peterson, ed., Jan. 2004) (“[Y]oung people
thrive when we listen to them, respect them, and engage with them in meaningful investments
in the community.”).
239
Cf. Quentin Wray, Prosperity Involves More than Just Economic Growth, BUS. REPORT,
Jul. 16, 2007, http:www.busrep.co.za/index.php?fSectionId=3267&fArticleId=3935499
(arguing prosperity is about more than money and “company profits and the ongoing
economic boom” alone cannot make “a truly prosperous society” when violence and
instability plague South Africa).
240
See id.; see also Ronald Bailey, Peace and Prosperity Through Productivity, REASON
ONLINE, Aug. 1, 2007, http://www.reason.com/news/printer/121697.html (“[P]roductivity
flourishes when people are free, safe, and justly treated”).
241
See Id.
242
See generally COLLINS, supra note 216.
243
See
3M,
http://www.3m.com/;
American
Express
https://home.americanexpress.com/home/mt_personal.shtml?us_nu=globalbar;
Boeing,
http://www.boeing.com/;
Citicorp,
http://www.citibank.com/us/index.htm;
Ford,
http://www.ford.com/; General Electric, http://www.ge.com/index.htm; Hewlett-Packard,
http://www.hp.com/;
IBM,
http://www.ibm.com/us/;
Johnson
&
Johnson,
http://www.jnj.com/home.htm; Marriott,
http://www.marriott.com/default.mi; Merck,
http://www.merck.com/;
Motorola,
http://www.motorola.com/;
Nordstrom,
http://shop.nordstrom.com/C/2375500/0~2375500;
Philip
Morris,
http://www.philipmorrisusa.com/en/home.asp;
Procter
&
Gamble,
http://www.pg.com/en_US/index.jhtml; Sony, http://www.sony.com/index.php; Wal-mart,
http://www.walmart.com/; Walt Disney, http://disney.go.com/index.
36
36
[Vol. 33 No. 1]
How does unethical behavior appear, and what do we do to control it? In
its most generic sense, unethical behavior exhibits itself in power and in
greed.244 Power gives the capability to control the choice of others. That has
potential to limit freedom, which is an essential component of thriving
commerce.245 Power does corrupt commerce.246 Power makes it possible to
direct the value exchange unfairly in order to maintain power and to prosper
at the expense of weaker trading partners.247 That is a greedy and unethical
stance.
What do we do about this? Well, we do two things: we introduce
governance in government,248 and we introduce rules and laws.249 This brings
it right into our conference. Both governance and law are created to
circumscribe behavior in such a way as to ensure a prospering and
sustainable society in the presence of corrupting elements.250
But there is an irony to this, and the irony is that governing involves
essential powers, and so does law enforcement.251 Thus, the corrupting
potential exists in the mechanisms intended to ensure minimal corruption.252
In democracies, we believe that the people should be given significant power
244
See Andrei Shleifer, Does Competition Destroy Ethical Behavior?, 94 AM. ECON. REV.
414, 414 (May 2004) (“[C]onduct described as unethical and blamed on ‘greed’ is sometimes
a consequence of market competition.”).
245
See FREIDMAN, supra note 230; see also Ronald Bailey, supra note 240.
246
See generally Bryan W. Husted, Wealth, Culture, and Corruption, 30 J. INT’L BUS.
STUD. 339, 344 (1999) (hypothesizing that “the higher the power distance in a country, the
higher the level of corruption in a country,” where “power distance” means that less powerful
members accept that power is distributed unequally).
247
See generally id.; Cf. Ethan B. Kapstein, The Political Economy of International
Cooperation: a View from Fairness Economics 7, INSEAD & CENTER FOR GLOBAL DEV.,
Dec. 2005, available at www.ethankapstein.com/Art/peicrev.doc (“Recognizing that the
governments of smaller countries might fear that they would eventually be ‘held up’ at the
bargaining table, the governments of powerful countries [i.e. the U.S. and Great Britain]
effectively committed with a rules-based system not to exploit their weaker trading partners.”)
248
See generally Carter, supra note 237, at 142 (“The provisions of the 1787 Constitution,
together with the Bill of Rights, suggest a government designed to put into practice the Theory
of Democratic Prosperity.”).
249
See, e.g., REVISED UNIFORM PARTNERSHIP ACT §404 (General standards of a partner’s
conduct).
250
See JAMES SVARA, The ETHICS PRIMER: FOR PUBLIC ADMINISTRATORS IN GOVERNMENT
AND NONPROFIT ORGANIZATIONS 145 (Jones and Bartlett Publishers 2006) (“Structural features
and legal requirements have been established in national, state, and local government to
promote ethics and reduce unethical behavior.”).
251
Cf. SUSAN ROSE-ACKERMAN, INTERNATIONAL HANDBOOK ON THE ECONOMICS OF
CORRUPTION 4 (Edward Elgar Publishing 2006) (“Research on corruption is difficult because
many causes of corruption also seem to be consequences of corruption.”).
252
See generally id.
37
over the governors, maybe not so much over the law enforcers, but over the
governors.253
To date, this seems to have been more successful than other attempts,
because we may have the possibility to change the governors who misuse
their power.254 However, we do have our moments of harmful behavior, and
we are all aware of Enron,255 Watergate,256 and recently the activities
associated with options.257 In Canada we have had the sponsorship scandal,258
the Nortel experience,259 and the same kind of options world. Our
entrepreneurs need, first of all, to be ethical. What do we do to prepare them
for that?
Secondly, they need to be prepared to lead their ventures to success in the
presence of barriers, of the barriers of governance and law that are intended
to minimize the corruption that destroys value.260 Unfortunately, these
barriers are often heavy burdens to the honest ethical enterprises and not
fully effective in deterring the exploitive actions of the self-serving
enterprises.261 How do we prepare our entrepreneurs to work in that
253
See generally Carter, supra note 237 (“[E]xistence of independent economic power as
counterweight to government”).
254
U.S. CONST. art. II, §4 (“The President, Vice President and all civil officers of the
United States, shall be removed from office on impeachment for, and conviction of, treason,
bribery, or other high crimes and misdemeanors.”).
255
See generally Eichenwald, supra note 231 (a scandal revealed in 2001 where Enron, a
leading energy company, was charged with fraudulent activities, particularly with its
accounting practices).
256
See generally J. Anthony Lukas, A New Explanation of Watergate, N.Y. TIMES, Nov.
11,
1984,
available
at
http://query.nytimes.com/gst/fullpage.html?res=9D0DE4DC1139F932A25752C1A962948260
(a political scandal in 1972 where a break-in to the Democratic National Committee’s
headquarters at the Watergate Office/Apartment Complex was eventually connected to
President Nixon leading to his resignation).
257
See generally Eric Dash, Report Estimates the Costs of a Stock Options Scandal, N.Y.
TIMES, Sept. 6, 2006 (scandal where the discovery of backdating, the practice of marking a
document with a date that precedes the actual date, led to a large decline in the stock market).
258
See generally Clifford Krauss, Canada’s Ex-Premier Denies Role in Quebec Fund
Feb.
9,
2005,
available
at
Scandal,
N.Y.
TIMES,
http://www.nytimes.com/2005/02/09/international/americas/09canada.html?pagewanted=print
&position= (scandal involving the Liberal Party, where funds were illegally used as incentives
to keep separatist forces at bay in Quebec).
259
See generally Peter Brieger, Nortel Scandal Deepens, CANADA.COM, Sept. 13, 2007,
http://www.canada.com/nationalpost/financialpost/story.html?id=b63e74ea-87b1-438f-a3bf9ff30ea0bff7&k=26724 (Nortel Network Corp. executives were charged by the Securities and
Exchange Commission for manipulating the company’s accounting).
260
See, e.g., Ann Bednarz, Execs Tell Regulators Sarbanes-Oxley Costs Exceed Benefits,
NETWORKWORLD, May 11, 2006, http://www.networkworld.com/news/2006/051106-soxcosts.html.
261
See generally id.
37
38
[Vol. 33 No. 1]
environment and to encourage them? This is not going to go away, and we do
have to work with it.
Finally, what do we do about entrepreneurial enterprises that are designed
to take value from the economy and deliver no value in return? Some of them
exist in the world of intellectual property.262 That’s a world where
proceedings are often very tough and costly. Some of these are the most
hazardous to the young risking entrepreneurs whose competitive and
confidence winning challenges are always pushing them to the limit. Here,
the challenges often end up in the courts where the standards of ethics,
justice, and rightness for the community or nation are to be maintained.
The responsibilities of governance and law are extremely important for
entrepreneurs and for prosperity.263 I am actually hoping during the hours of
this conference that we gain some new insights and confidence about how we
develop ethical entrepreneurs and ethical systems of governance and law in
which they will function. I hope this conference is going to give me some
new insights. Our prosperity, economic growth, job creation, and wealth
creation depend upon how well we do this.
Thank you.
DISCUSSION FOLLOWING THE REMARKS OF DAVID T.
MORGENTHALER AND DR. H. DOUGLAS BARBER
DR. KING: I had a few questions, which I wanted to start the session off
with. I was intrigued by this point – that we have to have a sense of ethics.
We have heard from David Morgenthaler and from Douglas Barber that
entrepreneurship is the lifeblood of our two economies, and I want to speak,
firstly, on this.
I was party to an entrepreneurship making disposable hypodermic
needles. I had to get out when I went to the top government job because we
were selling to the government, but my partner sold out to Pfizer, and he
made a barrel of money, and what he did was he bought everybody in the
company Cadillacs. He bought a plane and a place in Cape Cod and joined a
fraternity, which was known for excessive drinking.
262
See, e.g., Morag Macdonald, Beware of the Troll, THELAWYER.COM, 26 Sept., 2005,
available at http://www.thelawyer.com/cgi-bin/item.cgi?id=116783&d=122&h=24&f=46
(explaining the “patent troll” as a company “that holds a portfolio of patents where the only
business is . . . [legally] enforcing them against those who [have not] paid them for a licence
[sic].”).
263
See Bailey, supra note 240 (“[J]ustice is incredibly important to prosperity”); see also
Steve Strauss, Government's Role in Encouraging Small Business, E-JOURNAL USA,
http://usinfo.state.gov/journals/ites/0106/ijee/strauss.htm (last visited Oct. 29, 2007) (“Any
government that wants to encourage small business needs to produce laws that protect the
innovations of entrepreneurs.”).
39
What I am concerned about is the business of somebody putting
something back. In other words, you are successful; should we have funds
which these successful entrepreneurs may have to contribute to, because
beyond a certain amount of wealth is corruptive, I think. It was corruptive in
this case, and I am speaking from personal experience. And I think it is a
natural interest to do something like this.
You said that entrepreneurship is the lifeblood of the economy, and I
would like to get both of your thoughts how you bring that into play? Where
you continue this stream of entrepreneurship that has kept us going so long?
And what you think of this idea of possible voluntary contribution to a fund?
I know what it is to be an entrepreneur, because it causes domestic trouble
when you attempt to put a second mortgage on the house. It was not easy for
me, so I have been through it, personal experience. So perhaps you could
comment on that. I like the idea of the concern about ethics, and I love the
history of what made America great, but let’s continue that.
Do either of you have any thoughts on that?
DR. BARBER: My first thought is, if you live your life exercising your
self about what is good and right, how do you promote good things for all the
people that you affect?
I know at Gennum we often talked about who are our stakeholders were,
because we had statements of what we were going to do for our stakeholders.
It is easy to identify your customers as a stakeholder. The big difficulty that
we had was when we asked the question, do we affect our competitors? And
the answer was yes, we do. Then they are a stakeholder. How do we act for
the good of our competitors? When you get the stakeholder spectrum that
broad, the concern about how to be good is enlarged.
We broadened it beyond the city that we live in to the province, the
country, and the places we trade. We know we affect all of them. Certainly,
for Gennum, we have been generous to our community and to our country,264
even though we do almost no trade in the country.265 So I think it is an issue
of this broader consciousness. If you just think about the good as
accumulating prosperity for oneself, something has gone wrong, I think.
264
See
McMaster
University
–
Who
Contributes,
http://www.eng.mcmaster.ca/contributing/contributors.htm (last visited Oct. 20, 2007) (“Doug
Barber, an engineer, professor and entrepreneur, and Gennum Corp. of Burlington, Ont. Have
donated $1.3 million to McMaster University to create the Barber-Gennum Chair in
Information Technology.”).
265
See generally Gennum Reports 2006 Fourth Quarter and Year End Reports, available at
http://www.gennum.com/newsroom/pdfs/Q4_06.pdf (last visited Oct. 29, 2007) (quoting
revenue based by principal market for the three months ended Nov. 30, 2006, where $6,922 in
sales were to Canada, compared to $30,084 worth to the United States, Europe, and the Pacific
Rim).
38
40
[Vol. 33 No. 1]
DR. KING: I like Cadillacs, but I don’t think in my case the partner
worked out for the public good. But he did sell a lot of disposable
hypodermic needles.
David?
MR. MORGENTHALER: Well, you have raised a two-part question,
Henry: one is the question of ethics, which I am very glad to respond on, and
the other is a question of putting back into society for the benefits we have
had.
On ethics, we feel strongly about it for very practical reasons. We
invested in something over 250 companies.266 In those 250 companies we
have had five cases of some kind of fraud that we know about. There may
have been others that we haven’t caught. Five out of 250 is very good. Any
of you academics would give me a 98% or an A for something like getting it
right that many times, so we must be pretty good about picking society, of
picking people, but – and this is a big but – those five have cost us over $100
million in attained, but not yet cashed-in, profits.
Now, I am a slow learner, but losing $100 million, that I otherwise would
have but lose because somebody cheats, that will teach even me a lesson.
Now, I told this story before and the joke. Some of the entrepreneurs have
gone to jail. One of them died. I was asked if I had him killed, and my
answer was: no, he died before I could get the contract written.
But I do think playing by the rules is critical, and we totally agree that the
important thing to us is that entrepreneurs will not lie to us. I have seen
thousands of business plans over the years. I have very rarely seen one made.
They are always too optimistic. You have to discount for some things, but
when you have an entrepreneur that will deliberately lie to you about the
facts, even on small matters – we had a case recently where we had a very
attractive company, an interesting new technology that may just be a cure to
an important disease, and heading one of the most desirable jobs that we
have in our group. A man submitted an application for it, and on his
application, he showed that he had attended a certain college. He showed he
had graduated from it.
We were paying a recruiter over $100,000 to recruit for this job, and the
recruiter missed the fact that the man only attended the college; that he
hadn’t graduated. My young partner picked it up and came to me and said, “I
am troubled by this.” He said, “This man has lied to us, and I know how we
feel about people lying to us, and what do you think in regard to it?”
I said, “It is very simple.” I said that this man is going into a medical
company. We couldn’t care less whether he attended this college or
266
See About Morgenthaler, supra note 2 (“We have worked with entrepreneurs in more
than 250 companies since the firm's founding.”).
41
graduated. What we care about is: does he lie to us? Because graduating did
not matter, it was trivial. If he said he didn’t finish there are lots of good
reasons. Bill Gates didn’t finish college,267 Steve Jobs, whom we backed,268
didn’t finish college.269
I don’t care whether they graduated or not. I care whether they learned.
But I care a lot whether they lied to me, because the day will come that a
clinical trial will come, and there will be some bad results on that trial. If he
withholds that from us it may thoroughly affect the direction we take the
company next. So if he lies, he will lie out of here, and we cancelled the man
out immediately and didn’t continue him.
Interestingly, he came out of a company where he was said to be one of
the best of a company that had a very bad culture. An officer of that company
has gone to jail for bad culture. We will absolutely not tolerate it. The
venture business is one of the relatively cleanest businesses that I have ever
been involved with, and I have been involved in a lot of industries. I have
been in the scrap metal business to some degree, and God help you in that
business.
I took over as chairman of our Mexican company in the early 1960s,
about 40 years ago, and went down to Mexico and discovered that we had
sent an Englishman down when we opened up Mexico, and I discovered that
apparently his belief was that you had to bribe to do business in Mexico. So I
think any time anybody put their hand out to shake hands he put money in it.
We were bribing everybody we could see in Mexico. And actually, I got a
Mexican president in, and we cleaned it up. So I have seen all kinds of sordid
operations, but they are terrible from a business standpoint, and we won’t
have anything to do with them.
In the short-term, you can win sometimes – contract bidding, government
contract bidding. Again, all kinds of things have been thrown, but we just
won’t touch it. And in venture capital, I have seen things in earlier days
where venture capitalists behaved unethically. Back again many years ago,
we had a major venture capitalist. At his request we showed him the business
plan of one of our companies, and he showed that to one of his companies
that was directly competitive. They were bidding against him on a job. They
showed that plan to them, and the news got back to our company. It came
267
Stacy
Perman,
Dropping
Back
In,
INC.COM,
Jun.
2004,
http://www.inc.com/magazine/20040601/education.html (“[A]fter all, college dropouts Bill
Gates, Steve Jobs, and Michael Dell did just fine without a bachelor’s degree”).
268
See Tim Tankersley & Joshua Boak, Investors Turn Away from Ohio as Heavy Use of
Tax Dollars to Woo Jobs Doesn’t Pay Off, THE TOLEDO BLADE, Sept. 24, 2006, available at
http://www.toledoblade.com/apps/pbcs.dll/article?Date=20060924&Category=NEWS24&Art
No=609240334&SectionCat=&Template=printart (“Cleveland-based Morgenthaler Partners
funded Apple, Nextel, and 250 other startups.”).
269
See Perman, supra note 267.
39
42
[Vol. 33 No. 1]
back to us with very high indignation from one of the other major venture
capitalists, who was a partner, and he had the attitude of, tough, that’s the
way things are done.
Well, the hell that’s the way things are done! So we joined in a little
conspiracy just to make sure among all the deals we got, he saw only the bad
ones, and that went on for a while. He got the message. He was frozen out.
The bad deals where we might lose money, show them to him by all means.
We take it seriously.
DR. KING: Okay. Are there other questions? I have plenty of questions.
Yes, sir, right in the front row.
MR. GROETZINGER: Question for David Morgenthaler: Out of a
thousand companies that you would look at, and you said three are excellent
performers and one might be arguably a mega-performer, what are the
characteristics of those four that make them so superior? Is there a common
thread, or is it the product or service? Is it the market they are attempting to
meet?
MR. MORGENTHALER: I wish I knew for sure and I doubly wish I
knew when they walked in. The trouble, of course, and the reason that you
see the thousand, is that I often describe our business as shoveling rock. We
shovel a ton of rock to find an ounce of gold. And when you are shoveling it,
you don’t know what is going to be there. Inevitably, you get everything
right though. One of the problems that I have had in this region, one of the
things we ought to talk a little bit about – and it is an argument that comes up
a great deal with the Silicon Valley people, whether the culture is a major
factor, where a number of them love to believe it is the culture that does
everything – is with the willingness to let people fail.
Well, culture is certainly a factor, but the critical factor is the basic
opportunity – and I still like my three-legged stool. I like metaphors and I
like the concept. The whole business is a horse, a rider, and a race. The
concept, the technology is the horse. The entrepreneur is obviously the rider.
The race is the market that you are going into. You absolutely have got to
consider all three. You have got to get all the elements right. The venture
capitalist is none of those. He is an owner, a trainer. He ends up owning the
horse or a good deal of it, and he provides advice to the jockey. But you
fundamentally will find that there is a market; there is a kind of race.
Competitors are doing certain things; your horse will do certain things. If all
of those come together at a point in time –
As I have said, the S-curve theory that came out in the late 1960s, which
originally was applied to technology,270 I think applies very much to
270
See
generally
S-Curves,
INNOVATION
ZEN,
http://innovationzen.com/blog/2006/08/17/innovation-management-theory-part-4/ (last visited
Oct. 20, 2007) (“[T]he S-curve emerged as a mathematical model and was afterwards applied
43
businesses. Things mature, and we are trying to catch them down at the
bottom of this flattened S-curve, when you have a long run up and catch
them before they level off. The trouble with the region in the Rust Belt cities
is they didn’t realize the industries were at the top of their S-curves. But you
catch a market. You catch a group of people who do it a little better or a little
more energetically, and the competition doesn’t move in as well as it should
have, and they just end up winning.
We backed Apple Computer in our early careers.271 We had figured out
long since that this was going to be a huge market, and we were looking for
the people that were going to win. I think we went through probably 25
companies. We were a little put off by Apple because of the two young men,
Steve Jobs was a rather young promoter at that stage,272 and Apple didn’t
have a lot of proprietary technology.273
And one of our fears was that the Asian companies would be a problem.
These were fairly simple computers; and we were used to much more
complicated computers, we were much more complicated. How was Apple
going to win? Well, somehow it just became clear, these guys had just gotten
out ahead, and they were doing the right thing, and they were going to win.
So we backed it one round later, made a good deal of money out of it. We
would have made ten times as much money if we had been earlier, if I hadn’t
been a little stubborn about not recognizing they were going to be the winner.
I didn’t like the name. I didn’t like the immaturity of the entrepreneurs. I was
wrong on a number of counts.
And then again, sometimes you just get all the elements right. One of the
mistakes that is so often made in this part of the country – that is, in the older
mature regions – is that people don’t listen. And you tell them it takes all
three elements. People fall in love with a person, and they say he or she is so
wonderful he would back them in anything. That is absolute nonsense. I
know some perfectly good executives in the steel industry in this country,
some very fine people. If they were in some other industry, or they were at
some other point in time in the steel industry, they would do very well. They
are not stupid. They are not lazy. They just are in a tough time in that
business and in that market. Not all the automobile executives are stupid.
Some of their predecessors – I dumped General Motors out of my portfolio in
personal investments back in 1965, and my investment adviser said that’s unAmerican not to own General Motors, five percent dividend, and you should
to a variety of fields including physics, biology and economics”).
271
See Tankersley, supra note 268.
272
See generally Inventor of the Week, The Personal Computer, Lemelson – MIT Program,
http://web.mit.edu/invent/iow/apple.html (last visited Oct. 20, 2007) (Steve Jobs was born on
Feb. 24, 1955, and Apple Computer began in 1976 with Steve Wozniak).
273
See generally id.
40
44
[Vol. 33 No. 1]
own it. They have a 58 percent market share.274 If they get any more the
antitrust department will be on their backs;275 we sell to them, their costs are
extreme;276 their unions are overpaid;277 their management is arrogant.278 Get
it the hell out of my portfolio! They did, and the stocks have never done
better. I picked a good time to exit. You have to get all the elements together.
And that’s the reason I was making the point earlier.
The lack of entrepreneurship is not a cause; it is a symptom. It tells you
you have a later condition than you realize, and that is the point I want to
leave here. You are lacking innovation because innovation creates the little
horses. If the little horses are not being born, the entrepreneurs – the jockeys
– don’t hang around. They go to Silicon Valley.
We find a problem today. If we find an interesting company coming out
of The Cleveland Clinic, or coming out of some other source around town,
and we start to look for a jockey, we usually can’t find someone in town who
is qualified. We go out to recruit him. Where do you find him? You find him
in Silicon Valley, or you find him in Boston. Then you have a hell of a time
persuading him to move here because he says, “I like you and I like the place
and everything else. But if I lose my job, I don’t have another kind of job to
go to there. When I am in a big industrial parking lot in San Jose or Mountain
View or something of that kind, if I lose my job there, I can get two more
jobs in the industrial area without changing my parking place.” This is part of
the reality of it.
DR. KING: Well, thank you very much. Marty Gelfand?
274
See The General Motors Branding Lesson, Branding Strategy Insider, Oct. 8, 2007,
http://www.brandingstrategyinsider.com/2007/10/of-branding-gm-.html (“[S]trong brands
allowed GM to capture more than 57% of the U.S. market by 1955.”); cf. Jerry Dubrowski,
GM
Retools
for
Cyberspace,
CNN
MONEY,
Aug.
24,
2000,
http://money.cnn.com/2000/08/24/companies/gm_overview/ (“GM’s U.S. market share stands
at just over 28 percent today, down from almost 50 percent in 1965”).
275
See The General Motors Branding Lesson, supra note 274 (“Aware that pursuing more
market share could lead to antitrust actions and the threat of a breakup, GM fatefully shifted
its strategy”).
276
See Terry Box, Automaker Cutting 30,000 Jobs, Closing Plants: Experts Say GM Needs
New Designs, New Deals, DALLAS MORNING NEWS, Nov. 22, 2005, available at
http://www6.lexisnexis.com/publisher/EndUser?Action=UserDisplayFullDocument&orgId=5
74&topicId=100021821&docId=l:334286713&start=21 (“With General Motors' dramatic
plant closure announcement Monday, the embattled corporation is striving to cut some of its
huge costs and shrink itself.”).
277
See Kathleen Hays, Getting 'Intelligent' at GM, CNN MONEY, Nov. 22, 2005,
http://money.cnn.com/2005/11/22/commentary/column_hays/hays/index.htm (“Management
can complain all it wants to about “overpaid" union workers”).
278
See John Holusha, Humbler G.M. is Now Listening, N.Y. TIMES, Jan. 30, 1988,
available at
http://query.nytimes.com/gst/fullpage.html?res=940DE3D9133BF933A05752C0A96E948260
(“[O]nce arrogant G.M. executives speak today in humbler tones.”).
45
MR. GELFAND: Yeah. Professor Barber, I liked how you described
entrepreneurship as human, and I think Professor King illustrated that with
his own second mortgage, and you illustrated it yourself by saying that
successful entrepreneurs frequently have also failed in their previous
businesses.
I wanted to ask anyone from the panel if they think that our bankruptcy
laws, particularly on the recent revamping of the bankruptcy laws279 making
it more difficult to get out from an unsecured debt, have affected current
efforts to be successful entrepreneurs, particularly in, you know, those stopgap failures that inevitably happen?
DR. BARBER: I think we have to have David answer that. I keep on
saying that I have been involved–
DR. KING: Did you hear the question?
DR. BARBER: Yes, I think I did. I have been involved in five startups.
One hundred percent of them have been successful, which is not those kind
of statistics, and I don’t know where to lay the blame for that, but we have
had no bankruptcies so I don’t have any direct experience of that kind.
DR. KING: Do you have any experience, David, with respect to the
bankruptcy laws?
MR. MORGENTHALER: Well, we usually try to sell them before they
go bankrupt. But I want to talk to you, Doug, if you have got five out of five.
Let’s meet afterwards. Maybe we can make a deal.
I never lost money in a private company until I was over age 50, and I
somehow thought I had a magic touch. I got in the venture business and
made more investments, and I discovered I could lose money, and I did.
I don’t think much about bankruptcy – no entrepreneur thinks about going
bankrupt. That is something that happens to other people. That is not going to
happen to him. He would not be a part of it. I think if you talk to factoring
people – I was on a panel yesterday over at Case with their Research Data
Center,280 and they had factoring people – those people look at that kind of
thing. They are concerned about it. I don’t think we think much about the
bankruptcy laws. We don’t lend money. Even though we structure it in a
279
See generally Timothy Egan, Debtors in Rush to Bankruptcy as Change Nears, N.Y.
TIMES,
Aug.
21,
2005,
available
at
http://www.nytimes.com/2005/08/21/national/21bankruptcy.html?pagewanted=print (“[U]nder
the revised law, debtors who earn more than the median income in their state and who can
repay at least $6,000 will no longer be able to have their debts wiped out for a fresh start under
the more generous provisions of Chapter 7 of the bankruptcy code. Instead, they will have to
seek protection under Chapter 13, which requires a repayment schedule.”).
280
See Case Western Reserve University Research Symposium, (research symposium held
Apr. 11-12, 2007), available at http://ora.ra.cwru.edu/showcase/program.html (follow “Fast
Forward -- The Future of Funding” hyperlink) (last visited Oct. 20, 2007).
41
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[Vol. 33 No. 1]
convertible debt, it is basically equity, and we will end up losing it, and we
just try to recover something in the end.
DR. KING: Well, I don’t want to close this session. It has been a great
session, but we have this clock to deal with, and as you know, I am well
aware of the clock. I wanted to thank you, David Morgenthaler, for a
wonderful presentation and also Douglas Barber for raising some very
interesting questions. I thought this was a good session, and I thank you.
CREATING ENTREPRENEURSHIPS: FORM OF ENTITY;
MANAGEMENT PROVISION CONCERNS; DISPUTE
RESOLUTION PROVISIONS; GROWTH PROVISIONS –
IDENTIFICATION OF RIGHTS AND RESPONSIBILITIES OF
PARTICIPANTS IN ENTREPRENEURSHIP INCLUDING
ALLOCATION OF RISKS
Session Chair – Silvana Alzetta-Reali
Canadian Speaker – Gail Lilley
United States Speaker – Michael Wager
INTRODUCTION
Silvana Alzetta-Reali
MS. ALZETTA-REALI: Good morning. The second panel discussion
today is about creating entrepreneurship, and we have with us today Michael
Wager and Gail Lilley. Both Ms. Lilley and Mr. Wager are frequent speakers
at various conferences.
As our discussion of the morning topic evolves, the decision was to take a
step back and look at the creation of entrepreneurship from a policy
perspective first, and then focus on the actual processes involved, such as, the
choice of entity, the allocation of risk, responsibilities, and the like.
So I will now pass the baton over to both Gail and Michael who will be
presenting in a tag team formation.
47
42
48
[Vol. 33 No. 1]
Michael Wager*
&
CANADIAN SPEAKER
Gail Lilley*
MR. WAGER: Silvy, yes, we are going to do this a little differently.
Rather than having Gail and I present for 30 minutes each, on the entity
choice issues, allocations, responsibilities and the prospectus on the
American-Canadian side, we thought it would be interesting and more
engaging if we presented on an interactive basis.
We also wanted to step back and talk about some of the underpinnings of
the policies and laws as they relate to entrepreneurship. I did not realize,
however, at the time we made that decision, that we would be following a
distinguished panel, and, in a sense, we would be trying to enhance on
observations of entrepreneurship after David Morgenthaler had made his
presentation, but we will do the best we can.
When talking about the context for creating entrepreneurship, we ask the
fundamental questions about what is, or who is, the entrepreneur, and what
are the political, economic, and social environments in which entrepreneurs
are grown.
Certainly, we embrace and celebrate the entrepreneur in American
popular culture. However, I think David Morgenthaler said that was not
always the case. I think he said early in his career that someone said that he
was an entrepreneur, perhaps, because he could not hold a job. Today that is
certainly not the case. From an academic perspective, and from the
perspective of those of us that practice in the field of corporate law and,
certainly, in the business world, entrepreneurs are, in fact, celebrated for not
only the product of their labors but the way they engage in the world.
They are, if you will, the Evangelistic indigenous growth in America, and
I expect the same in Canada. In historical and geopolitical laws, American
capitalism has already been the counterpoint to centralized economies, which
raises cross border questions of why entrepreneurs do not thrive in other
types of economies.
It is clearly accepted wisdom that entrepreneurial activity equates to
economic growth over the long-term. But it raises some chicken and egg
Lilley & Wager—Creating Entrepreneurships
49
questions, which hopefully our presentation will begin to answer, or at least
raise as an acute question. The first of those causality questions is: Does
capital and access to capital attract entrepreneurs, or do entrepreneurs attract
capital? And then another interesting question is: Does U.S. public policy
and law drive, or even support, entrepreneurship?
With regard to U.S. public policy and legislative initiatives, or in my own
view sometimes obstacles, we find that perhaps there is not a coherent
strategy, either at the federal or state levels. I have observed that from a
variety of different perspectives in my own career and experience.
Though, notwithstanding the fact I am a practicing lawyer, there was a
tour of duty in my life as an entrepreneur, albeit it was at a time when it was
not easy to be perceived as an entrepreneur. In the late 1990s, I was involved
in a technology company in Denver, Colorado. I was the only fellow, of 300
people, that showed up with a tie. I became known as the tie guy. At this
stage, I was not an entrepreneur, but I did observe that I was the oldest
employee of the company, which was not yet 50 years old.
Dialogue with company employees in Colorado was different than my
dialogue with people in Cleveland, and I think the reason for that was that the
view of what an entrepreneur was was really quite different. In Colorado,
companies talked to people in civic life or engaged in policy or politics.
If you asked some of the people in this region, or in mature rust belt
cities, what an entrepreneur was, sometimes you got a simple response: an
entrepreneur is an individual who is self-employed and wants to be his own
boss. If you went back and looked at definitions in state addresses or other
pronouncements by politicians, you got a list of definitions of an
entrepreneur, which I will read to you.
Entrepreneurs are people who have different capital needs.1 Entrepreneurs
add value to the economy and generate a higher rate of return on public
*
Michael Wager is a lawyer with Squire, Sanders & Dempsey. He shares his time
between the New York and Cleveland offices. He focuses his practice on representation of
private and publicly held companies in matters of securities regulation, corporate finance,
corporate governance, mergers and acquisitions, and strategic growth. Mr. Wager has served
as counsel and adviser to, and director of, several private and public companies. He is active in
several civic and philanthropic organizations and is currently vice chairman and chair elect of
the Board of Cleveland-Cuyahoga County Port Authority and a member of the Board of the
Northeast Ohio Development Fund LLC. He serves on and has served on many other past
boards and commissions and has served as the Chairman of a Cleveland-based private equity
firm.
*
Gail Lilley has been a partner at Blake, Cassels, & Graydon since 1986. Her practice
involves a wide range of corporate commercial transactions with a principal focus on mergers
and acquisitions for both Canadian and multinational clients. Her particular expertise is in the
Canadian aspects of global business transactions, including the cross border structuring and
financing of those acquisitions. She also advises clients on corporate reorganization, private
financing, and equity issues and other more commercial relationships. Ms. Lilley is involved
43
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[Vol. 33 No. 1]
investment.2 Entrepreneurial businesses expand rapidly, and entrepreneurs
are more dependent on constantly changing technologies.3 Entrepreneurial
businesses have high growth potential.4
Also, taking a very local view, entrepreneurs are cash importers because
they sell products and services outside of the state.5 Entrepreneurial
companies are defined by revenue growth, and their resource needs differ
from small business in magnitude and kind.6 Finally, entrepreneurs need
greater access to research and development resources.7 These are all different
ways of looking at entrepreneurs.
From my own perspective, I think what would differentiate entrepreneurs
ultimately from small businesses, is that they seem to be individuals who
require some level of independence in the utilization of the resources made
available to them. Also, there are risk barriers, which make them different
from other kinds of small businesses. On that point, size probably does not
matter.
One of the questions that we may address today is whether or not there
are differences, cross border, in the characteristics of an entrepreneur. This is
in many major transactions. In 2005, she was involved in Pernod Ricard’s multi-billion-dollar
takeover of Allied Domecq, acting as Canadian counsel to Fortune brands. She has also had a
long time interest in educational issues and as a result has served on the Governing Council of
the Ontario College of Teachers.
1
See JAY KAYNE, KAUFFMAN CENTER FOR ENTREPRENEURIAL LEADERSHIP AT THE EWING
MARION KAUFFMAN FOUNDATION, STATE ENTREPRENEURSHIP POLICIES AND PROGRAMS, at 8
(Nov.
1999),
available
at
http://www.publicforuminstitute.org/nde/sources/reports/ngastudy.pdf
(explaining
that
Nebraska and California’s rationale for treating entrepreneurs differently from small
businesses in state policies and programs is because “[e]ntrepreneurs have different capital
needs”).
2
See id. (explaining Iowa’s rationale for treating entrepreneurs and small businesses
differently in state policies and programs is because “[e]ntrepreneurs add value to the
economy and generate a higher rate of return on public investment”).
3
See id. (explaining Massachusetts’s rationale for treating small businesses and
entrepreneurs differently in state polices and programs, is because “[e]ntrepreneurial
businesses expand rapidly and are more dependent on constantly changing technologies”).
4
See id. (explaining New Jersey and Michigan’s rationale in treating small businesses and
entrepreneurs differently in state policies and programs is because “[e]ntrepreneurial
businesses have high-growth potential”).
5
See id. (explaining Missouri’s rationale for treating small businesses and entrepreneurs
differently in government policies and programs is because “[e]ntrepreneurs are cash
importers as a result of selling products and services outside of the state”).
6
See id. (explaining North Carolina rationale in treating small businesses and
entrepreneurs differently in state policies and programs is because “[e]ntrepreneurial
companies are defined by revenue growth” and that “[t]heir resource needs differ from small
business in magnitude and kind”).
7
See id. (explaining South Dakota’s rationale for treating small businesses and
entrepreneurs differently in state policies and programs is because “[e]ntrepreneurs need
greater access to research and development resources”).
51
something that I am not sure about with regard to the U.S. and Canada, but
certainly, I have observed entrepreneurs during my experience in the U.S.,
and in experiences that our firm has had in emerging economies in Eastern
Europe and other parts of the world.
But as we observed earlier, there are cultural and demographic differences
even within the U.S. regarding the definition of an entrepreneur. I think this
has had an effect on state and federal policy and law addressing entrepreneur
activities. The general question that we perhaps want to raise in the backdrop
is whether governmental intervention is, in particular government policy and
law, effective. Is going beyond Adam’s invisible market forces worthwhile?
Should government be involved in policy and law beyond mere
encouragement? In fact, when government gets involved in going beyond
statements, creating policy and programs, does it have the intended effect?
In 1999, during the height of the tech boom on Wall Street, a study was done,
which looked at the state addresses and inaugural speeches in 36 states in the
United States.8 Even at the height of that euphoria with regard to
entrepreneurs and technology companies, only 25 percent of those speeches
and political pronouncements talked about entrepreneurs and expanding
businesses.9
And in those 36 states the programs that they had were inactive.10 The
tech transfer programs or capital programs, R & D programs and work force
development programs, actually proceeded like the Small Business
Administration (“SBA”),11 which we will hear about in this conference.
These were generally broadly based programs, which for me always raised a
question of whether or not policy and law have an effect on entrepreneurial
activity and the development of entrepreneurs.
Here in Ohio, the Department of Development has been involved on and
off over a period of years in tax incentives, specifically identified as drivers
of job creation.12 Yet, in 2002, when a study was conducted on companies
that were given job creation grants, it was found that for those companies,
there was no net job increase as a result of the investments made by public
8
See id. at 10 (stating the results of a study that surveyed state addresses and inaugural
speeches).
9
See id. at 10 (explaining that in 1999, only 25% of policy statements by state governors
addressed entrepreneurs).
10
See id. at 12 (stating that entrepreneurial development in the states that were surveyed,
received only .71% of the total state fund).
11
See
generally
SBA
Programs,
Small
Business
Administration,
http://www.sba.gov/aboutsba/sbaprograms/index.html (last visited Sept. 24, 2007) (discussing
providing programs and services to help small businesses succeed in the United States).
12
See Ohio Tax Reform, Ohio Department of Development (2006),
http://www.odod.state.oh.us/taxreform.htm (discussing positive impacts of ongoing tax reform
initiatives).
44
52
[Vol. 33 No. 1]
dollars.13 So again, does government intervention, going beyond the invisible
hand, have the effect we want in entrepreneurial activity?
As a counterpoint to those observations about U.S. policy and law, here is
Gail Lilley with the Canadian experience. Gail, does Canada have anything
different, or does it reflect the same?
MS. LILLEY: I just wanted to make two preliminary remarks, one being
that I was fortunate enough to attend Case Western on the Case Western
exchange program a number of years ago, and I think it was a very formative
experience, and I think it is a wonderful program.
The preliminary comment I wanted to make, which I frequently make
when I am speaking to Americans, is that the population of Canada is smaller
than the population of the State of California.14 So it is difficult to really have
a true comparison of the U.S. and Canada, but I think this statistic is always
important to keep that in mind.
When I started to think about the topic for this morning, I thought I would
find out what our government is saying about entrepreneurship, and the
quotes you see up on the screen are statements that were made by our
Minister of Industry in September of 2006, “Features of the Value of
Entrepreneurship.”15 Those are very strong statements. It is felt all Canadians
want entrepreneurship. It is also a bit of a political statement, by supporting
entrepreneurship through tax relief and red tape relief.
Now, there was a captive audience - speaking to a chamber of commerce
group in Saskatchewan - but it was an important statement, which reflected
13
See generally ZACH SCHILLER, POLICY MATTERS OHIO, WAL-MART SPECIAL: OHIO JOB
TAX CREDITS TO AMERICA’S RICHEST RETAILER (July 2002), available at
http://policymattersohio.org/pdf/wal-mart.pdf (criticizing the effectiveness of Ohio job
creation tax credits).
14
See Population and Dwelling Counts for Canada Provinces and Territories, 2006 & 2001
Censuses,
Statistics
Canada
(2007),
http://www12.statcan.ca/english/census06/data/popdwell/Table.cfm?T=101
(showing
Canada’s population in 2006 was 31,612); California QuickFacts from the US Census Bureau,
U.S. Census Bureau (Aug. 31, 2007), http://quickfacts.census.gov/qfd/states/06000.html
(showing California’s estimated population in 2006 was 36,457,549).
15
Maxime Bernier, Minister of Industry, Canada, The Value of Entrepreneurship, Address
Before the Canadian Chamber of Commerce Annual General Meeting (Sept. 17 2006),
available
at
http://www.ic.gc.ca/cmb/welcomeic.nsf/cdd9dc973c4bf6bc852564ca006418a0/85256a5d006b
9720852571ed005ba0d5!OpenDocument (describing entrepreneurship as “[…] an outlook on
life. It is the ability to see opportunities in your environment and exploit them to create
something new or make something better”). See also Gail Lilley and Michael Wager,
Creating
Entrepreneurship,
http://cusli.org/conferences/annual/presentations/2WAGER__Creating_Entrepreneurships_Po
werPoint_Presentation.PPT (last visited Nov. 7, 2007) (“Entrepreneurship is an outlook on
life. It is the ability to see new opportunities in your environment and exploit them to create
something new or make something better.”).
53
government and entrepreneurship. I also thought it was interesting to look at
a couple definitions of what an entrepreneur was, and I thought it was
interesting I chose the same definition as Douglas Barber.
That may be a Canadian thing, or perhaps a French bilingual thing, but
that route to undertake something is an interesting basis for this. The
definition on the broader statement of what an entrepreneur is was also made
by the Minister of Industry.16 It obviously is a statement that goes beyond
small business and what you think of as the individual creating a business for
himself, to a sort of philosophy that can affect big business and large
organizations. I like this definition because of its broader appeal.
So I think what we are going to talk about specifically as this program
progresses, with respect to Canada, is what does our government do to help
entrepreneurs do something? And this goes back to the earlier discussion
about entrepreneurs: Are entrepreneurs born or made?
The early focus we have taken is that they may be born, but they also
have to be helped and supported to be fully functional. So I thought we
would look at four major policy areas in Canada: competition policies, tax
policies, red tape reduction, and financial support.
Now, there are obviously a number of other policy areas that impact on
entrepreneurship. There are immigration policies that encourage successful
entrepreneurs to immigrate,17 securities policies that broaden exemptions
from registration,18 and prospectus requirements to promote investments.19
But as I say, I wanted to concentrate on these four.
MR. WAGER: From a U.S. public policy perspective, one of the
fundamental initiatives that you often see is legislative action with regard to
capital formation.20 Obviously, new business requires access to capital, and
one of the issues, particularly in regions like the North, other than Ohio, has
16
Bernier, supra note 15; see also Gail Lilley and Michael Wager, supra note 15.
See
generally
Canada
Immigration
–
Entrepreneur,
CanadaVisa.com,
http://www.canadavisa.com/immigration-canada-entrepreneurs.html (last visited Oct. 26,
2007) (describing an entrepreneur program that “seeks to attract people with business
experience who have the intention and ability to actively manage a Canadian business that will
positively impact the Canadian economy and create employment opportunities for Canadian
residents.”).
18
See, e.g., Securities Rules, New Brunswick Securities Commission, http://www.nbsccvmnb.ca/nbsc/iam_content.jsp?id=19&pid=0 (last visited Nov. 6, 2007) (stating that for
entrepreneurs there are certain exemptions from registration under New Brunswick securities
law).
19
See e.g. id. (stating that for entrepreneurs there are certain exemptions from prospectus
requirements under New Brunswick securities law).
20
See generally American Council for Capital Formation, ACCF Mission,
http://www.accf.org/about/index.html (last visited Oct. 26, 2007) (stating that for nearly thirty
years, the American Council for Capital Formation “brought the message to U.S. and
international policymakers, the media and the public that a nation’s economic strength and
stability depend on…policies to promote capital formation…”).
17
45
54
[Vol. 33 No. 1]
been that the limited access to capital may be a factor in why entrepreneurial
businesses have not succeeded here.21 But capital, as was stated earlier, is
only one of the elements that creates entrepreneurship. Capital, skilled labor,
technology, infrastructure, and a spectrum of resource availability, if not the
cause, are also important to entrepreneurship.22
But when you look at the capital formation spectrum, how much of that is
important to the creation of entrepreneurship? Earlier there was a discussion
about the roles of angels and smaller capital providers, and certainly here in
Cleveland we do not have that kind of load seed capital that we have seen, at
least today, in other regions of the country. And as a result of that, we have
seen increasing intervention by local not-for-profit or public entities, creating
venture capital pools,23 and this kind of intervention eases constraint.
Constraint on access to capital is really one of the issues that is important
in driving or creating entrepreneurship. In Northeastern Ohio, venture
capital, or seed capital, has been created by the actions of the not-for-profit or
foundation community.24 They provide either direct equity or forms of
indirect equity.25
21
See generally INDIAN AND NORTHERN AFFAIRS CANADA, CANADA’S NEW GOVERNMENT
INCREASES ACCESS TO CAPITAL FOR SMALL AND MEDIUM-SIZED BUSINESS IN YUKON,
http://www.ainc-inac.gc.ca/nr/prs/m-a2007/2-2900-eng.asp (last visited Oct. 26, 2007) (stating
the Canadian’s government investment in Yukon businesses will help them “overcome
challenges they are faced with because of a limited access to capital.”).
22
See generally Mark Drabenstott, Nancy Novack & Bridget Abraham, Main Streets of
Tomorrow: Growing and Financing Rural Entrepreneurs – Conference Summary, Federal
Reserve
Bank
of
Kansas
City,
http://findarticles.com/p/articles/mi_qa3699/is_200307/ai_n9267206/pg_2 (last visited Oct.
26, 2007) (“Ensuring access to capital is another key element of the entrepreneurial
ecosystem,” as well as “infrastructure and institutional support.”).
23
See
generally
Background,
The
Ohio
Capital
Fund,
http://www.ohiocapitalfund.com/background.asp (last visited Sept. 24, 2007) (discussing the
Ohio VC Statue, created “for the purpose of increasing the amount of private investment
capital available in this state for Ohio-based business enterprises in the seed or early stages of
business development and requiring initial or early stage funding”).
24
See generally THE GREATER CLEVELAND PARTNERSHIP, THE GREATER CLEVELAND
VENTURE
CAPITAL
REPORT
5
(2006),
http://www.gcpartnership.com/uploadedFiles/Miscellaneous/2006%20Venture%20Capital%2
0Report.pdf (describing initial seed investments as “typically $250,000-$1 million and
provided by friends & families of the entrepreneur, nonprofit venture development groups, and
grant funding sources”).
25
See generally About Case Technology Ventures, Case Technology Ventures,
http://ora.ra.cwru.edu/ctv/html/about.html (last visited Sept. 30, 2007) (describing how Case
Technology Ventures “invests in its portfolio companies in the form of convertible debt” and
“[i]n the event of a successful external financing, CTV will generally convert its debt to equity
in the company.”).
55
We have had actions by the state government, in the form of county and
local governments involved in microenterprise loans,26 and local guarantees
and bond funds by our port authorities and other county and city creatures.27 I
am not certain, however, that the policy behind these actions, are drivers of
creating entrepreneurship. For instance, the increased access to capital
generated by the government, the large private equity funds, and the private
equity D.C. firms, have accelerated entrepreneurial activity in no particular
location. Furthermore, there is reliance liquidity, and liquidity restraints are
questionable.
The SBA, from a federal perspective, has been involved in providing
capital to businesses,28 which they view as socially productive businesses.29
But again, is government policy accelerating activity, or is it, in fact, other
resources and other elements that give rise to the creation of entrepreneurial
businesses?
From the tax perspective, it is clear that tax policy does have some effect
on business decision-making. The question is whether or not it has a big
effect on startup and entrepreneurial businesses. Taxes do distort economic
decision-making, and perhaps higher taxes do have some deterrence to
entrepreneurial activity. However, I am not certain that tax policy, as
opposed to tax planning, in creating entrepreneurship is an important part of
the decision-making for creating entrepreneurial businesses.
Among the incentives, the business incentives in the tax codes that have
effect are, of course, tax credits;30 and certainly, they do have some
involvement on the planning going into entrepreneurial businesses. Sales tax
exemptions, particularly for machinery and equipment for certain kinds of
startup businesses31 and tax rates, as I say, do have some effect. I am just not
26
See generally Access to Capital, Economic and Community Development Institute,
http://www.econcdi.org/Capital.htm (last visited Sept. 30, 2007) (describing microenterprise
loan programs offered in Ohio by government and private entities).
27
See generally id. (demonstrating that the City of Columbus and Franklin County provide
“loans to clients who lack conventional collateral”).
28
See Investment Division, Success Stories, United States Small Business Administration,
http://www.sba.gov/aboutsba/sbaprograms/inv/INV_SUCCESS_STORIES.html (last visited
Sept. 30, 2007) (listing successful companies that have received investment from the United
States Small Business Administration through the Small Business Investment Company).
29
See generally About Us, United States Small Business Administration,
http://www.sba.gov/aboutsba/index.html (last visited Oct. 26, 2007) (“[They] recognize that
small business is critical to our economic recovery and strength, to building America’s future,
and to helping the United States compete in today’s global marketplace.”).
30
See e.g., Business Incentives Tax Credits, State of Ohio Department of Development
(2006), http://www.odod.state.oh.us/EDD/Tax_Credit.htm (describing tax exemptions and
credits available to entrepreneurs in Ohio).
31
See Carl Horowitz, New Life for Federal Enterprise Zone Legislation: Seven Lessons
From
the
States,
The
Heritage
Foundation
(1991),
http://www.heritage.org/Research/Regulation/BG833.cfm (“Sales tax exemptions on
46
56
[Vol. 33 No. 1]
certain that in creating an entrepreneurial business that they are an important
part of the decision-making. Certainly, the inheritance death tax part for
more mature businesses and business owners32 is an important part of
planning and is certainly one of the issues that lawyers might speak to when
talking to an entrepreneur. I am not certain that it would have that large of an
effect on the actual creation of entrepreneurial business. There is, in fact,
very little differentiation of the Tax Code between business generally and
entrepreneurs or startup businesses specifically.33
On the regulatory side, there is a much greater cause and effect between
entrepreneurs and what federal and state government does and the effect that
policy and law has on entrepreneurs. In a recent survey, entrepreneurs were
asked what regulatory policies they would like to see or what regulatory
initiative they would like to see from state governments to increase their
levels of activity or support for their activity.34 This is the rank order of the
things they want to see as a response from state government.35
First of all, they would like ease of getting through rules or regulatory red
tape, one stop service centers for permitting other regulatory compliance, and
paperwork reduction.36 Essentially, they wanted government out of the way.
The rank also showed utilities deregulation, securities regulation, and the
cost and the time to get business started.37
Entrepreneurs by their very essence are market disruptive forces.38
Therefore, they are free market risk takers and they view regulation
accordingly. So I think as obstacles and status quo businesses, the ones that
are being challenged by entrepreneurial differences are relying upon public
policy, and they are lobbying for public policy and law to preserve their
competitive position threatened by entrepreneurs.
equipment purchases . . .have been the most successful forms of relief used by states to
encourage business formation and job creation, particularly in small firms”).
32
26 U.S.C. § 2001 (2006).
33
See e.g., Business Incentives Tax Credits, supra note 30 (showing only the Ohio Job
Retention Tax Credit and the Technology Investment Tax Credit are awarded based on
number of employees or value of the business.).
34
Cf. KAYNE, supra note 1, at 18-19 (providing a survey of states on what state actions
have been taken to assist entrepreneurs).
35
Cf. id.
36
Cf. id. (listing that one-stop service centers, regulatory reforms, regulatory and
paperwork reductions are state policies that support entrepreneurs).
37
Cf. id. (listing that utilities deregulation and establishing processing deadlines are state
policies that support entrepreneurs).
38
See
generally
RUSSELL
SOBEL,
ENTREPRENEURSHIP,
at
2
http://www.be.wvu.edu/divecon/econ/sobel/Entr/Papers/FortuneEncyc.pdf (last visited Oct.
26, 2007) (stating that under the economist Joseph Schumpter perspective of entrepreneurship,
the “entrepreneur is a disruptive force in an economy.”).
57
The specific areas of law and regulation that provide some of the larger
obstacles are labor law policy, minimum wage, unemployment, and
insurance workers’ compensation.39 Immigration policy, particularly now in
the technology world where some of the more skilled personnel are not in the
U.S., or perhaps in Canada, needs regulatory reform,40 and as I said, to a
lesser degree, utility deregulation. And this is why it is not immediately
apparent, because the capital raising under the U.S. and Canadian regimes
include the issuance of securities.
MS. LILLEY: Before I talk a little more about the various policies to you,
it would be interesting to see what people think about how Canada compares,
and the first statement from the conference board report was actually referred
to by Sheridan Scott, The Canadian Commissioner of Competition, in a
speech that, not surprisingly, she also gave to a chamber of commerce
group.41 I will talk about this negative response later on.
Even though Canada is lagging behind in productivity, and certainly
lagging well behind U.S. productivity,42 I found a very interesting statement
on an industry website about Canada being the most cost effective location to
conduct sophisticated information computer technology research,43 for three
reasons: tax incentives, investments in R & D infrastructure, and the lowest
rate of cost in the G-7.44
And the interesting thing about those low labor costs is that salaries of
both scientists and technicians, which are obviously the largest labor cost
39
See generally Naomi Lopez, Barriers to Entrepreneurship: How Government
Undermines Economic Opportunity, INSTITUTE FOR POLICY INNOVATION (1999),
http://www.ipi.org/ipi%5CIPIPublications.nsf/PublicationLookupFullTextPDF/5B85FADDF
A72B382862567E300806F40/$File/Barriers149.pdf?OpenElement (describing the barriers to
entrepreneurship created by the government).
40
See generally Press Release, Electronic Industries Alliance, Beyond the Jobs vs. Trade
Debate: EIA Unveils Policy Playbook on Innovation (May 5, 2004) available at
http://www.eia.org/news/pressreleases/2004-05-05.153.phtml (on file with author) (stating that
the United States visa and immigration policy will influence the future of the United States
high-tech innovation economy).
41
SHERIDAN SCOTT, COMMISSIONER OF COMPETITION, CANADA, REMARKS TO RABOBANK
GROUP
(Apr.
5,
2006),
available
at
http://www.competitionbureau.gc.ca/PDFs/Rabobankspeech_e_mod1.pdf.
42
See
generally
Canada/United
States
Perspective,
Industry
Canada,
http://www.ic.gc.ca/epic/site/dsib-logi.nsf/en/h_pj00163e.html (last visited Oct. 26, 2007)
(stating that in key performance indicators, Canada is not as efficient in productivity and
competitiveness as the United States).
43
INDUSTRY CANADA, CANADA’S R&D LEADERSHIP IN INFORMATION & COMMUNICATIONS
TECHNOLOGIES
SIGNIFICANTLY LOWER R&D COSTS (June 10, 2005), http://strategis.ic.gc.ca/epic/site/icttic.nsf/en/it07292e.html.
44
Id.
47
58
[Vol. 33 No. 1]
component, are the lowest.45 I found a lot of surprising statistics when I
started to research this program. So let us talk about Canadian competition
policies.
This is a relatively recent speech that Sheridan Scott gave in April of
2006 in which it was stated that one of the ways to ensure that small and
medium-sized enterprises have an equitable opportunity to participate in the
Canadian economy is innovation as the crucial ingredient for economic
success.46 This statement is key here, because we are seeing that different
people coming at this problem from different perspectives are all sort of
focusing in on innovation.
The thrust of her speech was that the mission of the Chamber of
Commerce and the mission of the Competition Bureau were similar,47 but not
having attended the speech, I don’t know how successful she was in
convincing them of that. I think it was interesting from your point, Michael,
the importance of tax policy, because I think in Canada that tax policy is a
very important driver for entrepreneurial activity.
There are three prongs to that. They want to reduce the tax burden for
small business.48 They want to create incentives for research and
development,49 and they want to create incentives for investment in small
business.50 Now, the importance of tax policy in Canada may be tied to the
relatively high tax rates that Canadians pay and the desire to reduce taxes
whenever possible. I thought I would see what Finance had to say about this
on their website. The statement about entrepreneurs and small business
“being a key source of jobs,” is again a continuing government theme; that
statement was made in August of 2003.51
45
Id.
SCOTT, supra note 41, see also Gail Lilley and Michael Wager, supra note 17.
47
SCOTT, supra note 41.
48
See Promoting Entrepreneurship and Small Business, Department of Finance Canada
(2003), http://www.fin.gc.ca/toce/2003/entrepreneur_e.html (“Government is strengthening
support” for entrepreneurs and small businesses “by reducing taxes on small business income
and capital gains”).
49
See generally Scientific Research and Experimental Development Program, Canada
Revenue Agency (2007),
http://canadabusiness.gc.ca/servlet/ContentServer?pagename=CBSC_ON%2Fdisplay&lang=e
n&cid=1097152945354&c=Finance (“The Scientific Research and Experimental
Development (SR&ED) program is a federal tax incentive program to encourage Canadian
businesses of all sizes and in all sectors to conduct research and development (R&D) in
Canada…”).
50
See Promoting Entrepreneurship, supra note 48, (explaining that the Canadian
government introduced a number of tax measures to promote investment and entrepreneurship
in Canada).
51
See id. (“Entrepreneurs and small businesses are a key source of jobs and economic
growth in Canada).
46
59
And after that time, there were some improvements in the tax burden for
small businesses, the rates being lowered in certain circumstances,52 and the
amount of qualifying income for lower rates was raised.53 But I thought it
was interesting, these two examples from our recent March 9, 2007 budget,
they really fell more in the red tape reduction and lowering the compliance
burden.54
These seem like small contributions to these broad statements that they
want to support small business, but what they are really doing? They are
really lowering filing requirements. It is hard to see how that is going to kick
start much economic activity.
Those of you from Canada may be familiar with the Fraser Institute and
the Fraser Institute’s publications.55 I thought it was interesting that they
came out quite strongly in one of their publications that these preferential tax
rates for small businesses can actually act as a deterrent to growth and
expansion, because the jump in tax rates is so significant when they pass the
threshold of the eligible income.56
There were some interesting statistics in an article that in British
Columbia and Ontario, which had the lowest incremental increase, the rates
doubled, and in New Brunswick the actual increase was about 143 percent.57
So you can see that this is probably a deterrent to expansion. And certainly,
when you are looking at buying a small Canadian business or a Canadian
controlled corporation, increased tax rates and reduced access to certain tax
credit programs is something that people take into account in their economic
52
See generally Building on the Five-Year Reduction Plan, Department of Finance Canada
(2003), http://www.fin.gc.ca/budget03/bp/bpa2e.htm (showing that in year 2004, there was 30
billion dollars in tax relief in Canada) [hereinafter Reduction Plan]; see generally Budget
Information,
Department
of
Finance
Canada
(2007),
http://www.fin.gc.ca/access/budinfoe.html (Federal Budgets and Budget Speeches from 1995
to 2007 illustrating changing tax burden for small business).
53
See generally Reduction Plan, supra note 52 (explaining that Canada had improvements
in the tax burden for small businesses because the amount of qualifying income for lower rates
was raised).
54
See Gail Lilley and Michael Wager, supra note 15.
55
The Fraser Institute: Competitive Market Solutions for Public Policy Problems,
http://www.fraserinstitute.org/, (last visited Oct. 29, 2007) (The Fraser Institute is a non-profit
research group that “measures and studies the impact of competitive markets and government
interventions on individuals and society.”)
56
See Jason Clemens & Niels Vedhuis, Growing Small Businesses in Canada: Removing
(2005),
available
at
the
Tax
Barrier,
The
Fraser
Institute
http://www.fraserinstitute.org/commerce.web/publication_details.aspx?pubID=3113 (stating
that large increases in business income-tax rates are “strong disincentives for growth and
expansion”).
57
See id. (stating that the largest increase in business tax rates were in New Brunswick,
where “the statutory rate jumps 142.9%”)
48
60
[Vol. 33 No. 1]
modeling, when trying to decide how profitable the business will be on a
go-forward basis.
Also, not surprisingly, the solution for that problem proposed in the
publication was to reduce all business tax rates and then to aggressively
increase the eligible income for small business rates,58 which is very
consistent with the themes of the Fraser Institute.
One of the programs that had a lot of success in Canada for promoting
investment in small businesses were our labor sponsored investment funds,
and they began in the late 1990s.59 These funds had to be sponsored by a
trade union or a similar work organization,60 and they provided significant
tax benefits to investors.61 Even though the investments were relatively small
dollar values, the tax benefits for those investments were quite a bit.62
Now, I thought it was quite staggering that these funds, which were
estimated to account for up to 40 percent of all venture capital raised in
Canada,63 had poor returns.64 Many are microbusinesses. They are high
risk,65 and one out of a thousand brings success.66
58
See id. (“The optimal solution is to reduce the general business income-rate while
aggressively increasing the small business income eligibility”).
59
See generally The Venture Capital Industry in Canada, J. OF SMALL BUS. MGMT., at 4-5
(1997), available at http://www.allbusiness.com/business-finance/equity-funding-privateequity/623199-1.html (“The labor-sponsored funds (LBFs)… provide the greatest proportion
of money invested by the Canadian venture capital industry, largely because of generous tax
incentives.”).
60
See generally id. at 5 (explaining how the Canadian Federation of Labour sponsors
Working Ventures – an active type of labor-sponsored fund).
61
See generally id. (explaining that labor-sponsored investment funds provide “generous
tax incentives”).
62
See generally id. (describing one labor-sponsored fund, which was started in 1990 and
received “$15 million in seed financing from the federal government,” and raised “the rest
from individuals who received tax credit of up to 40 percent of the contribution amount.”).
63
See Labour-Sponsored Investment Funds, CBC NEWS (2005),
http://www.cbc.ca/news/background/personalfinance/labour_investmentfunds.html (“By some
estimates, labour-sponsored investment funds account for up to 40 per cent of all the venture
capital raised in Canada”).
64
See id. (“[P]oor returns have led many financial planners to stop recommending” laboursponsored investments to their clients).
65
See generally CANADIAN LABOUR AND BUSINESS CENTRE, THE ROLE AND PERFORMANCE
OF LABOUR-SPONSORED INVESTMENT FUNDS IN THE CANADIAN ECONOMY: AN INSTITUTIONAL
PROFILE, http://www.clbc.ca/Research_and_Reports/Archive/archive12169501.asp (“Laboursponsored fund tend to emphasize capital appreciation for shareholders as an overriding aim
by which other social and economic goals are made possible. CLMPC research concludes that
fund rates of returns must be considered in the context of venture capital investing which is
long-term and high risk in nature.”).
66
See generally Labour-Sponsored Investment Funds: FAQs, CBC NEWS, June 13, 2005
http://www.cbc.ca/news/background/personalfinance/labour_investmentfunds.html (“For most
LSIFs, the returns have been, shall we say, less than spectacular”).
61
The best success story is the early research in motion, our RIM, as we all
know it.67 Successful as this program has been, the program has been phased
out over time.68 The stated reason is that there has been such a proliferation
of funds, that it is hard for funds to raise significant capital to make them
meaningful to an investor and that some of the existing funds are too
meaningful to investors. I think this is an example of, certainly in Canada,
how tax incentives create capital for small businesses.69
The last tax policy is research and development credits. It is interesting
that on the Canada website, there is a government statement which says that
“innovation policy for the past 30 years” has been to “rely extensively on tax
incentives to promote R & D;”70 and this has been quite a successful
program. It is a combination of programs at the federal level and the
provincial level, providing tax deductions, accelerated write offs, and tax
credits.71
So, in the best circumstances, the after-tax cost can be less than 44 cents
on the dollar,72 which is a very good incentive program overall. And again,
Canadian small businesses receive the greatest business, so when they are
being acquired by a foreign purchaser, you do have to take into account that
you no longer will be entitled to those generous rates.
The last sort of policy initiative I would like to discuss is the government
financial support for small business. There are many programs at various
levels of government, but I just choose a program at random. The Canada
Small Business Financing Program is a program that allows qualifying small
businesses, which apply for a loan at a financial institution, to have the
benefit of a government guarantee.73
67
See generally Research In Motion Limited, Innovation in Canada (2003),
http://www.innovationstrategy.gc.ca/gol/innovation/site.nsf/en/in04212.html (“Research In
Motion Limited (RIM) is a leading designer, manufacturer and marketer of innovative
wireless solutions for the worldwide mobile communications market”).
68
See generally Eric Reguly, RIM on Edge of Big Global Growth Story, THE GLOBE AND
MAIL, at B2 (“RIM stumbled in the fourth quarter, when the number of new subscribers came
in about 100,000 below the company’s forecast.”).
69
But see id. (explaining that the “barrage of stories about the potential shutdown of
RIM’s U.S. service can probably take the blame for the slowdown (which only represents
about two weeks’ worth of new subscribers). Rising competition, notably from Palm’s Treo,
can take some of the blame, but only some.”).
70
See generally Canada’s R&D Leadership in Information & Communications
(2005),
Technologies
Significantly
Lower
R&D
Costs,
Industry
Canada
http://strategis.ic.gc.ca/epic/site/ict-tic.nsf/en/it07292e.html (“It has been Canada’s innovation
policy for the past 30 years to rely extensively on tax incentives to promote R&D”).
71
See id. (“One of the principal forces behind Canada’s success in attracting companies to
perform Research and Development is a core tax incentive program”).
72
See id. (“The net after-tax cost of R&D expenditures can be less than 0.44 cents for each
dollar spent”).
73
See generally Canada Small Business Financing Program, Industry Canada (2005),
49
62
[Vol. 33 No. 1]
They obtain the loan from the financial institution.74 The federal
government will reimburse 85 percent of the lender’s losses in the event of a
default.75 Now, that sounds like a good program. There are apparently 1,500
participating financial institutions with 15,000 branches across Canada.76 The
maximum amount that can be borrowed is $250,000.77 The funds have to be
used to purchase real estate, equipment, or leasehold improvements.78 There
are restrictions on what you can use the funds for, and you still have to meet
the basic lender criteria for obtaining that money.79 These hurdles may make
the program relatively inaccessible to many small businesses.
MR. WAGER: With all that as a preface, the notion of creating an
entrepreneurial business starts, at least as a legal matter, with a choice of
entity. Choosing an entity is not a simple choice, but it can be reduced to
certain determinants. For instance, some determinants in choosing an entity
are the capital structure, risk management or limiting liability, taxation, and
management and control issues.
We have talked about some policy and law behind that. In capital
structure, it is a balancing of the differing objectives of the investor, and for
the entrepreneur or the founder, these differing objectives would include time
horizons. Most professional investors, on the day they are making that
investment, are also thinking of their exit and certain rates of return.
Entrepreneurs, although certainly sensitive to the notion of creating
wealth, also have a different feel for the business they are creating. Likewise,
as we discussed earlier, the types of capital that go into entrepreneurial
businesses from the perspective of the professional investor are different
from that retained by the founder.80 This is the question of common equity
http://strategis.ic.gc.ca/epic/site/csbfp-pfpec.nsf/en/Home (“The Canada Small Business
Financing Program seeks to increase the availability of loans… by encouraging financial
institutions to make their financing available to small businesses”).
74
See id. (explaining that the Canada Small Business Financing program encourages
“financial institutions to make their financing available to small businesses”).
75
See id.
76
http://strategis.ic.gc.ca/epic/site/csbfp-pfpec.nsf/en/la00054e.html.
77
See id.
78
See Canada Small Business Financing Program, Industry Canada (2005),
http://strategis.ic.gc.ca/epic/site/csbfp-pfpec.nsf/en/la00231e.html (“The services of an
appraiser member of any professional association must be used for the purchase of real estate,
improvements to real estate and leasehold improvements, there are no exceptions”).
79
http://strategis.ic.gc.ca/epic/site/csbfp-pfpec.nsf/en/la00054e.html, supra note 78 (explaining
the lender’s responsibilities under the program).
80
See generally Tuck School of Business at Dartmouth, Center for Private Equity and
Entrepreneurship,
Private
Equity
Glossary,
http://mba.tuck.dartmouth.edu/pecenter/resources/glossary.html#convertablepreferredstock
(discussing the difference between common stock and preferred stock, in which common
63
versus preferred equity or subordinated debt. Most preferred equity that is
subordinated debt usually has convertibility features.81 Everybody is
essentially being valued on what the value is of common equity.
Management and control issues, are driven by the kind of business, the
kinds of investors – professional investors – involved, and the stage of the
business – early stage, mid stage, late stage.82 As discussed earlier, the
taxation policy is a driving force, but in this circumstance, it is the type of
entity and the way taxation applies to that entity. Are our earnings going to
be retained at least under U.S. law in the C Corporation83 because of lower
levels of taxation and earnings will be retained for future growth?
So the U.S. forms of organization are the sole proprietorship, which is not
a legal entity but, in fact, an individual who does his business as an
individual.84 The sole proprietor has a relationship with the government
primarily by contract,85 if at all, and risk managed by insurance,86 if at all. It
is not a recommended form of doing business, as you might imagine.
A joint venture is not a form of partnership, corporation, or limited
liability company, but rather a contractual relationship between parties that is
stock is held by “founders, management and employees,” and preferred stock is held by
investors.).
81
See generally id. (stating that convertible preferred stock “gives an owner the right to
convert to common shares of stock. Usually, preferred stock has certain rights that common
stock doesn’t have, such as decision-making management control, a promised return on
investment (dividend), or senior priority in receiving proceeds from a sale or liquidation of the
company. Typically, convertible preferred stock automatically converts to common stock if
the company makes an initial public offering (IPO). Convertible preferred is the most common
tool for private equity funds to invest in companies.”).
82
See generally Rebecca Buckman, Venture Capitalists Mentor Their Fledglings, THE
WALL
ST.
J.,
March
14,
2006,
available
at
http://www.kodiakvp.com/kodiak/news/?article=03_14_2006&id=06062818329991.php
(discussing that more venture capital investors are “trying to foster better management
practices” in start-up companies.).
83
See generally Invest in Canada: Selecting a Business Structure, Government of Canada
http://www.investincanada.com/en/809/Selecting_a_Business_Structure.html#corporation
(last visited on Oct. 26, 2007) (describing the different entity structure available in Canada for
businesses) [hereinafter Selecting a Business Structure].
84
See generally Sole Proprietorship Basics, http://smallbusiness.findlaw.com/businessstructures/sole-proprietorship/sole-proprietorship-basics.html (last visited Oct. 4, 2007)
(explaining that a sole proprietorship is a “one-person business”).
85
See generally Craig Miller, Revised Ohio Campaign Finance Law, World Services
Group,
(2007)
http://www.worldservicesgroup.com/publications.asp?action=article&artid=2049
(demonstrating that sole proprietorships can contract with the government).
86
See generally Sole Propietorships…Business Simplicity, LifeInsuranceHub.net (2005),
http://www.lifeinsurancehub.net/soleproprietorships.html (explaining the need for insurance
because in a sole-proprietorship “everything the proprietor and his family own is at risk”).
50
64
[Vol. 33 No. 1]
generally employed by corporations who are using contracts to do business
with other corporations.87
The forms that are generally suggested or considered for the entrepreneurs
are the limited partnership,88 which is less likely to be used these days
because of the regulations of the general partner, or the S Corp.89 Oftentimes
the decision does come down to a C Corp., which would be used for the
efficiency of lower tax rates on retained earnings, or the LLC, which is the
standard, because of pass-through taxable elements.90
From the Canadian perspective, I suspect it is similar, but there may, in
fact, be some differentiation.
MS. LILLEY: Well, as you expected, the determinants for entity choice
are quite similar in Canada.91 The forms of organization are similar, but there
are some differences, and I want to talk about three entities: LLCs, unlimited
liability companies, and franchising. LLCs, I know, are very popular in the
U.S, but they have proven to be a bit of a conundrum for cross border use
because, to date, they have not been entitled to the benefits of the
Canada-U.S. tax treaty, which is a problem.92
In the March 19th budget, the Minister of Finance in Canada announced
that the Canadian and U.S. treaty representatives had agreed in principal on
major elements of an updated tax treaty.93 One of the elements of the treaty,
87
See
generally,
Joint
Ventures,
Encyclopedia
of
Small
Business,
http://www.enotes.com/small-business-encyclopedia/joint-ventures (last visited Sept. 26,
2007) (explaining that joint ventures use contracts to conduct business).
88
See generally ELMER R. KIEHL & BRUCE W. MARION, THE USE OF PUBLIC LIMITED
PARTNERSHIP FINANCING IN AGRICULTURE FOR INCOME TAX SHELTER, NORTH CENTRAL
REGIONAL PROJECT 21, available at http://www.aae.wisc.edu/fsrg/publications/mono1(2).pdf
(last visited Oct. 1, 2007) (“The limited partnership has been seized upon by these
entrepreneurs as an opportunity to achieve rapid growth”); but see Michael Spadaccini, The
Legal
Ins
and
Outs
of
Forming
a
Partnership,
ENTREPRENEUR.COM,
http://www.entrepreneur.com/startingabusiness/startupbasics/businessstructure/article77980.ht
ml (last visited Oct. 1, 2007) (“Limited partnerships have fallen out of favor recently because
of the rise of the limited liability company”).
89
See generally Spadaccini, supra note 88.
90
See generally Why More Business Owners Choose LLCs, LLC.COM,
http://www.llc.com/LLC_Benefits.html (last visited Oct. 4, 2007) (explaining that one of the
advantages of an LLC is the “pass through taxation”); see also 26 C.F.R. § 301.7701-2 (2007)
(creating standards to determine the tax classification of a business organization).
91
See generally Selecting a Business Structure, supra note 83 (describing the different
entity structure available in Canada for businesses).
92
See generally Allan R. Lanthier, Treaty Benefits for LLCs?, CANADIAN TAX
FOUNDATION (1999), available at http://www.ctf.ca/articles/News.asp?article_ID=968 (stating
that using United States LLCs for investment into Canada “has been hampered by the lack of
treaty protection”); see also Paul L. Barnicke & Phyllis R. Roy, Treaties and Transparencies,
CANADIAN TAX FOUNDATION (2006) (“If similar changes are made to the Canada-US treaty, it
is widely anticipated that Canada will extend treaty benefits to passthrough LLCs”).
93
See generally ERNST & YOUNG, TAX ALERT, FIFTH PROTOCOL TO CANADA-U.S. TREATY,
65
which was announced, was the extension of treaty benefits to limited liability
companies.94 This is very helpful because many people want to hold their
Canadian affiliate through an LLC. But that is a bit down the road.
The treaty has to be finalized and has to be approved by the Canadian
government, and as I understand, the United States Congress as well.95 I
believe that January of 2008 is a very aggressive and optimistic time frame
for passage, but at least we, in Canada, have come to grips with LLCs.
I am just going to touch briefly on franchising, and then I will come back
to the unlimited liability company. Franchising is not, obviously, a form of
entity, but it is very popular in Canada,96 and I think it is also fairly popular
in the U.S.
I always think of it as a bit of a hybrid entrepreneurial model, and I
thought it was interesting that the Canadian Franchise Association website
has a statement on it that says that “[i]f you would like to be in business for
yourself but not by yourself, then franchising may be right for you.”97 This is
an interesting concept because the key is the innovation and the idea, because
pretty much everything else is delivered to the franchisee, and the franchisee
can be in business for him or herself. I think you cannot overlook franchising
when talking about entrepreneurs.
Unlimited liability companies, is a bit of an entrepreneurial tail in itself.
When U.S. tax law changed and it introduced the check-the-box rule,98 U.S.
tax professionals stumbled on an old part of the Nova Scotia Company’s Act
http://www.ey.com/Global/assets.nsf/Canada/Tax_Alert_2007_No_11/$file/TaxAlert2007No1
1.pdf (last visited Oct. 26, 2007) (describing the principal elements of the Canada-U.S. Tax
Treaty).
94
See Grant Thornton, Transfer Pricing Update North America (2007),
http://www.grantthornton.com/portal/site/gtcom/menuitem.8f5399f6096d695263012d2863384
1ca/?vgnextoid=ffd28971d74b2110VgnVCM1000003a8314acRCRD&vgnextfmt=default
(“The federal budget of March 19, 2007, included several international tax measures,
including . . . extension of treaty benefits to U.S. limited liability companies”).
95
See generally id. (“Budget proposals that relate to changes to Canadian domestic tax law
will become effective following ratification by Parliament. The proposals relating to changes
in the Canada-U.S. Income Tax Convention will become effective once agreed between the
Canadian and U.S. negotiators and accepted by the respective governments and legislatively
endorsed.”).
96
See
generally
Susan
Ward,
Franchising
your
Small
Business,
http://sbinfocanada.about.com/od/franchiseinfo/a/franchisingbiz.htm (last visited Sept. 25,
2007) (describing that franchising is a very popular choice for people who want to start
businesses).
97
Making
the
Right
Choice,
Canadian
Franchise
Association
(2007),
http://www.cfa.ca/Page.aspx?URL=MakingTheRightChoice.html.
98
See
generally
Debra
Moses,
NSULCs:
Made
in
Nova
Scotia,
http://www.camagazine.com/6/0/3/2/index1.shtml (last visited Sept. 25, 2007) (“[T]he ‘checkthe-box’ rules… permit a Canadian corporation, formed under federal or provincial law and
whose members have unlimited liability, to be treated as a flow-through entity for US tax
purposes.”).
51
66
[Vol. 33 No. 1]
that permitted the incorporation of a company where the liability of the
members was unlimited.99 During the dissolution of an unlimited liability
company, if the assets of the company were not sufficient to satisfy the
creditors, the shareholders had unlimited liability, which is the exact opposite
of where you think you would want to be, but this type of legal entity proved
to be very attractive to U.S. investors.100 It is taxed as a corporation in
Canada,101 so you do not have to worry about all sorts of other cross border
complication issues. The unlimited liability company also has a flow-through
treatment in the U.S.102 So, there was a huge stampede to incorporate these
Nova Scotia unlimited liability companies.
The Nova Scotia government thought this was a wonderful opportunity,
and increased the incorporation fee to $6,000 Canadian,103 which, anyone
who is in practice would know, is way out of proportion to any other fee like
that. Likewise, Alberta, which of course, is one of our most entrepreneurial
provinces, saw the exodus of corporations to Nova Scotia and amended their
corporation statute in the last year or two to permit the liability of
shareholders to be unlimited.104 Now, of course, there has been a bit of a
flow-back of corporations to Alberta,105 and just last week we received a
99
See generally id. (“[T]he Nova Scotia Companies Act is the only Canadian law that
allows for incorporation by members having unlimited liability”).
100
See generally TAX EFFICIENT INVESTING IN CANADA: DISPELLING THE MYTHS, TAX
BULLETIN,
MCMILLAN
BINCH
LLP
(2004),
available
at
http://www.mcmbm.com/Upload/Publication/Tax-Efficient%20Investing%200704.pdf
(explaining that Special hybrid entities that can be formed in Canada, such as the Nova Scotia
unlimited liability company is popular with foreign investing by affording a “flow through”
status for the purposes of the domestic tax rules allowing non-resident investors to consolidate
foreign and domestic profits and losses and thereby reduce the cumulative rate of tax imposed
on the corporate group).
101
See Moses, supra note 98 (stating that Nova Scotia unlimited liability companies are
“regarded as a true corporation,” which allows for tax benefits for these companies).
102
See id. (stating that Canadian corporations, whose members have unlimited liability are
“treated as a flow-through entity for US tax purposes”).
103
See
Miller
Thomson
LLP,
Doing
Business
in
Canada,
http://www.millerthomson.com/mtweb.nsf/web_files/nmis6dnkad/$file/DBIC_FullBook_emai
l.pdf? (last visited Sept. 25, 2007) (“The Nova Scotia government currently charges CDN
$6,000 to establish a NSULC [Nova Scotia unlimited liability company]…”).
104
See Cassels Brock Lawyers, Business Reorganization Group e-COMMUNIQUÉ (2007),
available at http://casselsbrock.com/publicationdetail.asp?aid=1380&pid= (“Alberta recently
made provision for ULCs, a corporation where all liabilities flow through to shareholders and
are not caught within the corporation itself”).
105
See generally Robert Omura, The Alberta Unlimited Liability Corporation, Canon &
Partners,
http://www.matrimoniallaw.ca/Practices/Corporate_Commercial/Articles/The%20Alberta%20
Unlimited%20Liability%20Corporation%20(Jan%203%202006).htm (last visited Oct. 28,
2007) (stating that the amendments to the Alberta Business Corporations Act will make
“Alberta more attractive to foreign investors and business.”).
67
notification that the Nova Scotia corporation fee has been reduced to a
thousand dollars106 from a law firm in Nova Scotia we do business with. I
think that is a nice little entrepreneurial story.
MR. WAGER: One additional thing – oftentimes there is a default to the
LLC as the choice of entity for entrepreneurs because of its pass-through
quality.107 There is a downside to this, and this is a cautionary tale, that I
observed firsthand, of a company that was capitalized through traditional
professional investor capital and the common equity of the founder together
with equity. The concept was attractive, and there was some traditional bank
financing from GE Capital. This company was organized as an LLC, which
was a bit unusual.
In the early years, there was expected to be losses, and those losses, of
course, were enjoyed by the investors. Unfortunately, the business model did
not evolve as expected by the entrepreneur and the funder, and there was a
necessity to recapitalize and restructure the company, including a settlement
of the senior debt.
Consequently, since this was a pass-through entity, which had seemed
attractive at the outset, you had forgiveness of debt income, which flowed
through as phantom income to the founder and the investors for the reduction
of debt. This was something that was never anticipated at the outset and
certainly not from the lenders. If this had been a C Corp., it would not have
flowed through to the investor.
So oftentimes the LLC, which is almost a default standard for organizing
startup entrepreneurial businesses, does have this feature, but again, there
was something extraordinary about this where you had traditional senior debt
financing at the outset.
Also, as part of the program elements that we were to cover today was an
allocating list involving disputes between founders and funders in creating an
entrepreneurial business. This is a relatively well-worn path on the terms and
conditions of contracts, that is, the equity purchase or debt purchase
agreements between an entrepreneur and its professional capital providers
and are fairly well interested from contracting. The provisions of
performance by the founder and funder depend on the circumstances, but in
general, the funders are providing capital over a period of time at the outset,
106
See
Stewart
McKelvey,
Nova
Scotia
Incorporation,
http://www.smss.com/en/home/corporateservices/services/novascotia.aspx (last visited Sept.
25, 2007) (stating the price to incorporate for an unlimited company is $1,000).
107
See generally LLC Overview, INCNOW: Agents and Corporations, Inc.,
http://www.incnow.com/about_llcs.shtml (last visited Oct. 28, 2007) (“A common reason a
business might choose to become an LLC is because of an LLC’s tax classification flexibility
– A new LLC incurring losses or owning capital appreciation assets like real estate operates as
a sole proprietorship or partnership so that losses and capital gains pass through to the
owners.”).
52
68
[Vol. 33 No. 1]
according to the terms and conditions that are negotiated pursuant to the
needs of the business.108 The founder, or the entrepreneur, has certain
performance obligations with regard to the growth of the business. However,
failure to live up to either founder or funder obligations can give rise to
breach.109 These issues were generally dealt with under a relatively standard
indemnification provision in the security purchase agreements; these
indemnification provisions are generally the basis of the relationship between
founders and funders.110 The scope of the indemnity is rather basic. The
limitations on indemnity can be negotiated and oftentimes are.111 From the
entrepreneur’s perspective, the important aspect is to understand how dispute
resolution is undertaken.
Entrepreneurs do not enter into relationships with funders expecting a
dispute. In effect, they do arise, and from the perspective of an entrepreneur,
arbitration is advisable as opposed to litigation, which is an expense. The
determination issues between founders and funders, again, are usually a
negotiated item.
At the point in time when businesses get in trouble, professional investors
want control and the opportunity to change management. In some cases they
take advantage of the opportunity to claw back or take control of the equity.
This terminates the relationship between the investor and the entrepreneur.
Finally, before we get to questions, we come back to the chicken and egg
issue we began this discussion with: Do entrepreneurs attract capital, or is it a
multi-directional process, and does the process change across borders? The
effects of policy and law on an entrepreneur’s growing business are not
clearly understood. However, capital alone does not do it, and a spectrum of
resources are necessary.
108
See generally Angel Groups Provide Funding Option for Business Start-Ups; Focus on
Venture Capital an Achilles Heel for Entrepreneurs, says Angel Capital Association, BUS.
Sept.
8,
2004,
available
at
WIRE,
http://findarticles.com/p/articles/mi_m0EIN/is_2004_Sept_8/ai_n6185522 (“Angel investment
groups… are emerging as an attractive seed-stage funding alternative for start-up
companies…”).
109
See
generally
Suing
for
Breach
of
Contract,
AllBusiness,
http://www.allbusiness.com/legal/litigation/4141-1.html (last visited Oct. 27, 2007)
(describing contractual obligations and how they can give rise to breach).
110
See generally Legal Information for Entrepreneurs, Gaebler Ventures,
http://www.gaebler.com/Understanding-Indemnification.htm (last visited Oct. 28, 2007)
(stating that entrepreneurs should understand indemnification, which is a “contractual promise
in which one party agrees to protect another party from financial loss.”).
111
See generally Ken Clingen, An Overview of the Business Acquisition Agreement, DCBA
BRIEF, http://www.dcba.org/brief/janissue/2007/art20107.htm (last visited Oct. 28, 2007)
(“The parties often negotiate the indemnification provision’s duration, any basket or
deductible on indemnifiable claims, and the ceiling or cap on damages recoverable from the
indemnifying party.”).
69
I came across an article that was in the American Agricultural Economic
Association Journal in 1988, which does answer the fundamental question,
and according to this article, they concluded that the egg came first.112
With that, I turn to Gail to see if you have any concluding remarks as
well.
MS. LILLEY: To respond to Michael’s discussion about structuring the
allocation of rights and obligations, I had a client early in practice who was a
strategic buyer who made serial acquisitions. The client said that I should
always keep in mind the KIS principal, which, I think everyone knows, is:
Keep it simple. I thought this would help rationalize some of the complex
things that we were discussing earlier.
So, we have the founder with the idea and we have the funder with the
capital, and they have three common goals: they want to protect the idea,
they want to create a tax efficient structure in which to carry on the business,
and they want to have a simple operating model, which I think is important.
Small businesses have very few resources and they have few executives. It is
difficult for small businesses to thrive, when you have a complex operating
model. I think one reason for this difficulty, sometimes, there are significant
tensions between the founder and the funders. Founders really want to keep
their ideas, whether it is a product or a service, if the business is not
successful. Not surprisingly, funders are fairly unhappy with this notion
because they paid to invest in the idea and they really do not want to see the
founder run off with the idea if the business fails. Everyone wants to limit his
or her risk as much as possible and everyone wants to retain as much as
possible if the business is a success. Sometimes lawyers do not do small
business people any favors when they are trying to structure these
arrangements, because it takes a long time to sort out these arrangements,
and the business operator takes his eye off the ball. The lawyer devotes a lot
of his energy and attention to trying to settle these documents. I have seen
circumstances where businesses have floundered immediately after the
investment because of people not sticking to their commitment. I just think
that has to be something that has to be kept in mind from a process point of
view.
112
Walter N. Thurman & Mark E. Fisher, Chickens, Eggs, and Causality, or Which Came
First, 70 AM. J. OF AGRIC. ECON. 237, 238 (1988), available at
http://links.jstor.org/sici?sici=00029092%28198805%2970%3A2%3C237%3ACEACOW%3E2.0.CO%3B2-1.
53
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[Vol. 33 No. 1]
DISCUSSION FOLLOWING THE REMARKS OF GAIL LILLEY AND
MICHAEL WAGER
MS. ALZETTA-REALI: Okay. Before asking the audience if they have
any questions, I actually have a question, which ran to my mind based on the
chicken and egg casualty article and the answer to that question. I had no
idea it was the egg, but keeping that in mind, then, with an entrepreneurial
metaphor, what would be the chicken and what would be the egg and,
therefore, what would be the answer?
MR. WAGER: Well that is interesting. I, as you said, served as vice chair
of the Port Authority here in Cuyahoga County. There is a belief in this
region, and not unlike the belief of many of us in the rust belt cities, that if
we create capital, if we build pools of funds, that we will have the
entrepreneurs come to us. That is, in fact, not what the literature says and, in
effect, has not necessarily been the experience. This is not to say that pools
of capital provided by government or by the NGO sector do not have a
positive effect. I am just wondering whether it is transformative. I do not
know whether it is an either/or because I think it is a multi-dimensional
process.
You need all the resources together, as David Morgenthaler said, the
jockey and the horse, and that is what is going to make it work. When you
have fallen behind the curve of economic development, the way someone
will mature, you try to replicate what, at least, the picture is of the healthy
entrepreneurial environment. This includes a lot of seed capital and other
investment capital, and ultimately this creates the glue of entrepreneurial
activity.
MS. ALZETTA-REALI: I suppose the egg in this analogy is the capital
for you, but we have the other answer, and I think David Morgenthaler
actually said that capital may not necessarily follow entrepreneurs. I am not
sure I have an answer, and it is a difficult question to answer. However, we
will receive further questions from the audience. Any questions? Yes, Dr.
King?
DR. KING: I noticed on the dispute resolution provisions there, you did
not amplify it, is this a perfect case for mediation, or should that be
arbitration? This is addressed to Michael Wager with comments by our
Canadian friend also. What is the best way to resolve the disputes?
MR. WAGER: I have to make an admission here – the dispute resolutions
part of the agreements in funding entrepreneurial businesses do not get that
much attention from corporate and corporate finance lawyers. We think it is
boilerplate.113 It probably deserves more consideration by people involved in
113
See
generally
Boilerplate,
InvestorWords.com,
http://www.investorwords.com/516/boilerplate.html (last visited Oct. 27, 2007) (stating that
71
actual dispute negotiation and resolution. The mediation, arbitration, and
litigation are all the potential bad outcomes that seem to be on the back of the
agreements, so I do not know that I have a really insightful answer to the
question.
DR. KING: Do you have any comments on that?
MS. LILLEY: Well, it is interesting. There was a great wave of
enthusiasm for arbitration as an alternative to litigation in Canada because it
was perceived as being speedier and less expensive.114 However, I think as
large complex disputes have moved into the arbitration field, arbitration has
become as expensive and time consuming as litigation.
It is interesting – your comment about mediation. In our litigation
process, if there is a lawsuit that the parties have to arbitrate, they can go to a
nonbinding mediation process.115 I recently had a situation where a client had
been negotiating with a municipality for a number of years to finalize
something, and they were just stuck. I had asked them whether they wanted
to consider voluntary nonbinding mediation, and they were not enthusiastic
about it. I thought it would have been a good idea.
MS. ALZETTA-REALI: At Coca-Cola, when I think about our joint
venture negotiations, we do not place an executive committee amongst the
joint venture partners. So, if we end up in a dispute, it will first go to an
executive committee to negotiate the dispute. Consequently, since the
negotiation is between the partners, the negotiation might go on for a long
period of time.
However, there are designated officers and a designated time period to
resolve the dispute. If these constraints do not work, we then attempt other
methods of dispute resolution. This may involve bringing in a technical
expert, depending on what the issue is, banker expertise, investment bankers,
accounting firms, just about anything. The last resort is arbitration because it
is expensive, but it may end up there.
DR. BARBER: This is a question about the funders. I have to sense that
in Canada the amount of funding that supports new ventures from angels is
about twice the amount that comes from venture capital. I do not know
whether the angels have the same problems that venture capitalists have. I
boilerplate language is a “standard form or template used in a contract or other legal
document.”).
114
See
generally
Tom
Pedreira,
Arbitration,
LAWYERS.COM,
http://canada.lawyers.com/lawyers/C~1001557~CND/Arbitration.html (last visited Oct. 28,
2007) (“Arbitration can be fast, quick and easy, whereas lawsuits can drag on for years and
years.”).
115
See
generally
News
&
Information,
ADR
Institute
of
Canada,
http://www.adrcanada.ca/news/faq.html (last visited Oct. 27, 2007) (stating that one of many
significant reasons to mediate, is because the “process is non-binding; the outcome is within
the control of the parties.”).
54
72
[Vol. 33 No. 1]
have a sense that venture capitalists are very much more advanced in
financing, legalities, and governance. Angels are big players and they are a
group of financiers or funders. Any comments?
MS. LILLEY: Well, that is actually interesting because I do not know any
statistics, but in my mind there are two kinds of angel groups: one being the
family member angels and the other being sort of professional angels.
Professional angels are people who have a pool of capital and are interested
in making small and personal contributions. As family member angels, their
investments are personal and small for startups, and I know for the family
angels the documentation tends to be somewhat light, and the formality tends
to be somewhat light. But in truth, the repercussions for a failed business
involving family angels are fairly significant.
Whereas professional angels, with the documentation and the formality,
are a little bit closer to a venture capital model, but there is no emotional
investment. So, if the business fails, it is one of the 999 type deals that did
not work out so well. You are right, there is a bottom layer, and it is just so
much trouble to get money from professional funders, from banks, et cetera,
even from government programs, and much easier to find people who are
prepared to put a small amount of capital at a high risk.
MR. HERMAN: I realize we are discussing the appropriate form of
business entity for entrepreneurial activity, and the availability of capital as
the key ingredient, and we will be discussing some other aspects involved in
entrepreneurial growth and in the encouragement of new forms of business
later today and tomorrow. However, there are aspects missing, which we will
discuss later in the program, but can you address the importance of the rule
of law, the ability of the entrepreneur to have his or her intellectual property
protected, the availability of appropriate infrastructure and a whole range of
other things that affect entrepreneurial growth and development?
We take the issue that Michael talked about, development of
entrepreneurial activity in this region, the United States. What role does
infrastructure play? What role does the rule of law and the ability to protect
entrepreneurial enterprise have on the growth of entrepreneurship in any
particular area?
Let me just throw this out: It may be a lot easier to develop
entrepreneurial activity in, say, the United States, than it might be in some
country or some region in Eastern Europe where the rule of law does not
allow entrepreneurial activity to flourish and grow without the appropriate
protection.
MR. WAGER: That is a very good point. These aspects are not part of the
program that we had planned for today, but as I look out in the audience, I
see one of my colleagues, and she and I are now engaged in a new venture in
[Eastern Europe] for very significant dollars.
73
While it is a very hotly negotiated transaction between two very
sophisticated players who are creating a joint venture in the emerging Eastern
European economy, the rule of law issue, as you put it, is something which is
of great concern to both of the parties. It does not necessarily affect the
negotiation between the operator and the funder, but it does certainly affect
the decision-making with regard to embarking in this joint venture. For
instance, it is uncertain what kind of returns you would expect for taking this
kind of additional risk because you have less stable legal protection, a less
mature legal system.
I think it affects the risk and reward decision-making. I do not know if it
necessarily affects the kind of structural issues we were talking about for
entrepreneurial businesses, except perhaps a recognition that you can set it
up, use whatever best practice you want to establish the entity, and negotiate
the relative rights of the parties. Nevertheless, if they are not enforceable in
the local jurisdiction, I am not certain exactly what the benefit of the hard
work will be on the front end.
MS. LILLEY: This is actually an interesting discussion because if I think
about an entrepreneur, I am not sure in our current legal environment that
small business people can really afford to enforce their rights to take
advantage of the rule of law in their home jurisdiction. It is just so time
consuming and expensive to enforce legal rights these days that I think
unfortunately, it undermines the system a little bit. That is a bit of a
controversial remark.
MR. GROETZINGER: In the written materials, I was surprised to come
across things to avoid in setting up ventures, and one of the most common
mistakes is asking potential investors to sign a nondisclosure agreement.
They say it is a risky move, and they would not sign anyway. That is a
surprising statement. I just wonder what you have to say about that.
MR. WAGER: Those are materials which I did not provide because it
would be contrary to the advice that I would give an entrepreneur, sharing his
or her proprietary observations and information, and I also do not think it is
an unrealistic expectation. You have to find some level of confidentiality to
be able to observe business.
I am struck by that, and I would love to have an argument to make if I am
on the side of the professional investor, which I usually am, to say, “No, we
do not sign confidentiality agreements,” but I do not think we are going to be
seeing that many business plans if we do not.
MS. ALZETTA-REALI: I definitely agree with that.
MR. ABRAHAMS: Michael, on one of your earlier power point screens,
there was a statement “Economic Freedom Drives Economic Activity
Relating to Government Controls.”
55
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[Vol. 33 No. 1]
I would like to know, are you advocating some type of laissez-faire
capitalism or different government regulatory controls or scheme, depending
on the size or innovative issues of small or startup companies?
MR. WAGER: I am going to give you a lawyer’s answer. No. It is not a
yes or no answer because, as relates to the issue of rule of law and protection
of intellectual property, clearly we need rules. What I was making reference
to, and I am really borrowing from the literature, is that we are sitting in a
state that has this issue in starting businesses. Oftentimes, depending on what
business you are in, there are so many levels of compliance that the issue
becomes prohibitive or a decision is made to basically ignore the compliance,
which is a liability that funders are not going to enjoy.
That is what I was getting at – there needs to be some level of regulatory
and paperwork reduction or reform. So, starting new businesses will not be
quite as burdensome and, frankly, as costly. For instance, entrepreneurs pay
law firms in order to make sure they can start a business, without a dollar of
revenue of profit that already has significant legal compliance costs.
MS. ALZETTA-REALI: Obviously, Coca-Cola is not a starting business,
but one of the impediments I find working in the Canadian office, when it
comes to the company attempting to continue to be entrepreneurial, is the
innovation. Innovation is what is going to keep us being as productive as
possible. What would be wonderful, furthermore, speaking from a North
American perspective, would be to have some harmonization in rules; this
lacking is an impediment for us in Canada.
It may not be our innovative idea, but it is an innovative idea coming
from R & D, from another company, or it could be from Asia, Africa, or the
U.S. When we try and create the innovative leverage in Canada, the
regulations and the landscape is so different from that in the United States
that we either take the air out of the balloon or just do not launch the product,
because it takes too much time. So, some harmonization in laws, not
necessarily less regulation, but harmonization, would really help the
entrepreneurial spirit.
MR. WAGER: There is actually some good news on this front. There was
a time when you raised capital in several states in the U.S., notwithstanding
the fact that you met federal exemption, you still had a variety of filings.116
There are still some filings for raising capital, like blue sky compliance.117
116
See generally Matt Storms, Securities Compliance is Part of Raising Capital, WIS.
TECH. NETWORK (2006), http://wistechnology.com/article.php?id=3495 (discussing the
various federal securities exchange commissions requirements for companies that are raising
capital).
117
See generally Richard Alvarez & Mark Astarita, Introduction to the Blue Sky Laws, SEC
LAW.COM, http://www.seclaw.com/bluesky.htm (last visited Oct. 28, 2007) (explaining that
Blue Sky Laws are securities laws and rules of each state).
75
For the most part, if you need federal exemption today, you are likely to have
an exemption at the state level.118 A dozen or so years ago that was not the
case.
MR. HERMAN: I have a question on dispute settlement. This always gets
lawyers active and engaged on dispute settlement, and you touched on
dispute settlement. I think mention was made of the lack of support for
nonbinding mediation. I can understand that because why would the clients
want to go through the cost of a process that ultimately was nonbinding? It
really does not make sense, and I think in a commercial document it is
probably something that, as counsel, I certainly would not recommend.
One of the problems in contractual dispute settlement like arbitration,
lawyers advising clients to not pay enough attention to the bind. At the end of
the negotiation, something is thrown in that says the parties will arbitrate in
accordance with arbitration rules, without realizing those are very complex
rules, and if they are not specifically tailored to the agreement, you can get
into long and complex processes.
The lesson seems, and I would like to have comment from the panel, for
counsel to address dispute settlement provisions and to make sure that they
tailor the dispute settlement provisions to the needs of the clients and the
entrepreneurial activity that is involved. In other words, you can construct
fast, efficient, effective, and binding arbitration provisions. The issue that I
see often is that you have to convince the clients that they need to pay a little
more to get those provisions drafted, and that it is in their interests,
particularly when we are talking about small businesses, it is in their interests
to spend a bit of money, their money, to ensure the arbitration provisions are
lean, effective and efficient, rather than just throwing in a boilerplate
arbitration provision in the agreement. Comments?
MR. WAGER: I am guilty of the latter.
MS. LILLEY: That is a very interesting comment because obviously one
of the approaches for arbitration is to effectively draft your own procedure
and attach it as a schedule to the document, but it is kind of interesting
because clients frequently don’t have a lot of heart. That sometimes is the
kind of thing that gets left to the end of the process.
It is important because, of course, when you have a cross border deal,
your client will say, “What do you mean we have to go to New York to do
our arbitration? It is going to cost us this. It is going to cost us that.”
Moreover, if you are working with a foreign jurisdiction, “What do you
mean we do not have a right to have it in English?” So your point is very
well taken. What I think many law firms are doing is trying to create some
standard documents that can be, at least, used as a template starting point so
118
See generally Storms, supra note 116 (describing federal and state Blue Sky securities
laws for issues of securities).
56
76
[Vol. 33 No. 1]
you are not always reinventing the wheel, but where you can have a separate
negotiation on the arbitration provision.
MR. ROBINSON: Just a small comment: Observation that harmonization
would help between the U.S., Canada, and also certainly Mexico,
entrepreneurship and everything else. I have been very disappointed to see
that the committees and working groups under NAFTA, I think we have got
twelve formal ones, do not meet and do not work and they were supposed to
harmonize all kinds of things.
In 2005 with a lot of publicity, we created this Security and Prosperity
Partnership between the three countries.119 To the best of my knowledge,
nobody yet can figure out what the heck it does, but maybe one of the things
it could do is to get those committees and working groups to do what they are
supposed to do and start harmonizing things. So call your MP and complain.
MS. ALZETTA-REALI: I will do.
DR. KING: It was a good session.
119
Security and Prosperity Partnership of North America, http://www.spp.gov/ (last visited
Nov. 6, 2007) (discussing the background of the formation and purpose of the Security and
Prosperity Partnership of North America).
WHAT IT MEANS TO BE AN ENTREPRENEUR
Session Chair – Lawrence Herman
Speaker – A. Malachi Mixon, III
INTRODUCTION
Lawrence Herman
MR. HERMAN: I would like people to gather so we can start the
afternoon. Please come in and be seated. Ladies and gentlemen, we want to
start this afternoon’s session.
My name is Larry Herman, and I have the privilege of presiding this
afternoon and introducing our speaker. Those of you who are old hands at the
Institute conferences and those that may be new this year, I think will
appreciate not only the depth of the issues that we examine, but the quality of
the presenters.
The Institute takes pride in seeking out and obtaining for those who attend
the best people in the business and the best people we can find, people who
will give presentations of quality, and today’s speaker is no exception.
In fact, Mal Mixon is a person of extreme qualifications to speak on what
it means to be an entrepreneur. And we have handed out biographies. They
are in the material, and I don’t mean to read in detail Mal’s biography, his
background, and experience, but let me tell you, if you look at the first
paragraph in his biography, it tells the whole story.
As you know, he is the chairman and CEO of Invacare Corporation, a
leading manufacturer and distributor of healthcare products in the healthcare
industry.1 But when he began with them 27 years ago, the annual sales were
$19 million, and today those sales have reached $1.5 billion.2
So that tells you a lot about his ability to speak of entrepreneurship. He
holds both his B.A. and M.B.A. from Harvard.3 He is a director of a number
1
About
Us,
Invacare
Corporation,
http://www.invacare.com/cgibin/imhqprd/inv_company/company_info.jsp?s=0&area=Main&WT.svl=topNavLink9 (last
visited Oct. 12, 2007).
2
Id.
3
Our
Officers,
Invacare
Corporation,
http://www.invacare.com/cgi-
77
57
78
[Vol. 33 No. 1]
of listed companies on the New York Stock Exchange and is someone who
can lead us through the discussion this afternoon and tell us about what it
means to be an entrepreneur.4
bin/imhqprd/inv_company/officers.jsp?s=0 (last visited Oct. 12, 2007).
4
See Officers and Directors Detail of Invacare Corp IVC (NYSE), Reuters,
http://stocks.us.reuters.com/stocks/OfficersDirectorsDetails.asp?rpc=66&symbol=IVC&office
rID=33635 (last visited Oct. 12, 2007).
*
A. Malachi (Mal) Mixon, III is Chairman of the Board and Chief Executive Officer of
Invacare Corporate (IVC:NYSE), the leading worldwide manufacturer and distributor of
medical product for the home health market. 2005 sales were $1.5 billion. Mal led a
leveraged buy-out of Invacare in 1979, when sales were $19 million. Mal serves on the boards
of The Sherwin-Williams Company (NYSE), The Lamson & Sessions Company (NYSE) and
Primus Venture Partner, L.P, a Cleveland leveraged buy-out company. Additionally, Mal has
been an active investor in several successful Cleveland-area ventures, which became public
companies including Royal Appliance Manufacturing Company (NYSE) and STERIS
Corporation (NYSE). The American Association for Homecare (AAHomecare) presented Mal
with the 2006 Humanitarian Award in September, recognizing his industry leadership. Also,
during 2006, Mal was honored by the NAACP Cleveland Branch as the recipient of the 2006
Freedom Fund Award and the Lorain County Urban League presented Mal with the Whitney
M. Young Humanitarian Award. In November 2005, the National Conference for Community
and Justice (NCCJ) presented Mal with its 2005 Humanitarian Award and the Juvenile
Diabetes Research Foundation (JDRF) honored Mal with the 2005 Living and Giving Award.
Mal and his wife, Barbara, were honored in November, 2003 by the Achievement Centers for
Children for their civic and philanthropic contributions to Northeast Ohio. In 2002, Mal
received the Business Statesman Award from the Harvard Business School Club of
Northeastern Ohio. He received the American Association for Homecare Leadership Award
in 2001 in recognition of his dedicated leadership in promoting sound public policy affecting
homecare providers and manufacturers. In addition, he received the Distinguished Citizen
Award from the Greater Cleveland Council, Boy Scouts of America. He was honored as the
Master Innovator at the 2000 Anthem Blue Cross and Blue Shield/Small Business News
Business Conference. In 1999 and 1992, Mal was awarded the International Business
executive of the Year Award by The Cleveland World Trade Association. He was honored by
the National Multiple Sclerosis Society with the Hope Award for distinguished civic and
community service and the Student Free Enterprise (SIFE) organization presented him with
the America Free Enterprise Legend Award in 1997. Mal was inducted in 1996 as a charter
member into the Cleveland Business Hall of Fame. The Paralyzed Veterans of America
honored him with the 1996 Corporate Patriot Award in recognition of his significant
commitment to the PVA and to all those who have sacrificed in defense of our country. The
National Society of Fund Raising Executives Greater Cleveland Chapter honored Mal in 1995
as Outstanding Philanthropist. In 1992, he was awarded the Inc. Magazine Master
Entrepreneur of the Year Award for Northeast Ohio. The Harvard Business School Club of
Cleveland honored Mal with the Dively Entrepreneurship Award in 1984. A graduate of
Leadership Cleveland (1986), Mal’s current civic activities include serving as Chairman of the
Board of Trustees of The Cleveland Clinic Foundation and the Cleveland Institute of Music.
He also serves on the Visiting Committee of the Harvard Business School and the boards of
the BioEnterprise and MWV Pinnacle Capital Management, a fund investing in minority
ventures. In 1992, Mal established a chair in entrepreneurial studies at the Weatherhead
School of Management at Case Western Reserve University in Cleveland, Ohio. In 1997, he
established a Mixon Scholarship in each new freshman class at Harvard College for student
from Oklahoma and Northeast Ohio. Originally from Oklahoma, Mal is a graduate of Harvard
Mixon—What it Means to be an Entrepreneur
79
So without further ado, I will turn it over to Mal.
SPEAKER
A. Malachi Mixon, III*
MR. MIXON: Thank you very much, and it is a pleasure to be here this
afternoon. Hopefully, I won’t put you to sleep after your lunch. But, I want to
start out by telling a little vignette about a father who had two sons, and both
his sons turned out to be quite successful.
One turned out to be one of the world’s great lawyers, and the other one
turned out to be one of the world’s great entrepreneurs. The lawyer was a
pessimistic son. Every time the father gave the son a present that son would
analyze it in such detail that he would find something wrong with the gift.
So this particular Christmas the father decided that he was going to try to
help. Well, first, the other son was so optimistic he was unrealistic about the
world, so the father decided on two special gifts to get these children to be a
little more even keel in looking at life.
For the one that became the lawyer, he bought the most incredible,
expensive home computer for his Christmas present. The son took the
present, and about an hour later came back and said, “Dad, I like the present,
but there are so many things this computer should be doing, that it is not
doing, and here are some defects in the software.”
For the other son, the father went down to Thistledown and got horse
manure and put it in a box and wrapped it up and put a ribbon on the box.
That son got his present out from under the Christmas tree and opened the
box, jumped up with excitement, ran out the back door, and disappeared for
about a half hour.
Finally the son came in and jumped up and gave his dad a big hug and
said, “Dad, I can’t thank you enough for my Christmas present.”
And he said, “Son, I don’t quite understand.”
He said, “Daddy, I know there has to be a horse around here somewhere.”
So I wanted to just lead into the subject of what is entrepreneurship, and I
thought a lot about this. It is a word that gets thrown around loosely, but in
my mind, an entrepreneur is a creator, a builder, not an administrator of
Collece (BA) and Harvard Business School (MBA). Between degrees, Mal served four years
in the U.S. Marines Corps, including a year in Vietnam, attaining the rank of Captain. Combat
declarations include the Air Medal with Oak Leaf Cluster and Navy Commendation Medal
with Combat “V”. Mal and his wife Barbara, have two children, Elizabeth and Ki, six
grandchildren, and live in Hunting Valley, Ohio. He enjoys hunting, golfing and playing the
piano.
58
80
[Vol. 33 No. 1]
business and most certainly, he is an optimist. We can give any of you a
corporation to oversee, and you can probably take it to the next level. Don’t
mess around with it a lot and keep the good people you have, and it will
probably do pretty well on its own. And occasionally, we have some people
who take over big companies doing quite well, and they go the other way
because they don’t listen to their good people.
And to my mind, the entrepreneur can take something that someone else
doesn’t see value in and create something. Entrepreneurs almost always have
their total net worth at risk or a good part of their net worth at risk.5 So when
they go home at night, it is not about salary, wage – it is about losing
everything or winning quite a bit.6
I think entrepreneurs understand capital creation, and that’s something a
lot of people don’t understand. You know, they think that if I can make
another hundred thousand dollars, that’s going to put me in this particular
economic class or vision I have of myself. Once you learn how to do it, it is a
lot of fun.
And you obviously don’t want to go back to the idea of wages or salary. I
think an entrepreneur frequently can visualize value when others cannot.
Frequently, it is a business that everybody else has given up on, that went
bankrupt, et cetera. There are all types of entrepreneurs, but they are, as I say,
creators or builders of a business. I think they tend to think outside the box
and don’t generally accept the conventional view.
Secondly, I want to talk about what causes an entrepreneur to succeed; I
don’t think anyone knows the answer to that question. But in my mind, it is
really a collection of life’s experiences. Many of the successful entrepreneurs
I know started down the conventional path of working for someone else,
working for another company. I always advise young people, and I say,
“Make your mistakes on somebody else’s money, and then learn, and then
when you have your opportunity, you will have the skill-set to go along with
your desire to be an entrepreneur.”
And when I look back over my life – and I don’t know how many of you
remember this about your own education in grade school and high school –
but I never once in my life ever had a teacher say to me, “Mal, are you going
to own something?” They always said, “Mal, who are you going to work for
and what do you want to be when you grow up?”
5
See GERALD A. BENJAMIN & JOEL B. MARGULIS, ANGEL FINANCING: HOW TO FIND AND
INVEST IN PRIVATE EQUITY xxvii (Wiley Publishers 1999), available at
http://books.google.com/books?id=QbQfWTmHDEC&pg=PR27&lpg=PR27&dq=entrepreneurs+are+risking+their+networth&source=web&ots
=22wFR9AsWF&sig=7L1TRgpG4qgkReCJOgKmWALa-9Y#PPR5,M1.
6
See generally id.
81
In my mind, I never thought about owning a company or having a
company all to myself. Most teachers don’t understand capitalism, so there is
no way that they can teach the subject.
So part of the reason we don’t have more entrepreneurs is that teachers
don’t teach children what they can be, even without money. Certainly, as I
tell my story, I had no money, and I will tell you in greater detail about that. I
think their risk profile is different.
You know, a lot of people see me as a risk taker. I don’t see myself as a
risk taker. The things in which I get involved, I have a high confidence level
that it will succeed. I launched my entrepreneurial career in 1979 after I had
worked eleven years in industry; I didn’t have any net worth. So I didn’t
have anything to lose really except maybe a job, and I knew I could get a job
somewhere else.
I want to tell you about my background because I think it is relevant to
the issue of why I am an entrepreneur and how you can become one. I grew
up in Oklahoma in a small town – 1,100 people – real cow country. My
grandfather was a country doctor and came to this town in the 1890s.
I was born in the same house as my father, delivered by my grandfather.
My dad was away in World War II, and so I was around my grandfather a
lot. Neither of my parents went to college. Fortunately, they were smart and
well read, and we had a lot of intellectual conversations that I would come to
appreciate later in life, but certainly, academically, I was not challenged in
grades one to twelve in the little country school.
So because of that, I was able to do a lot of different things like play
sports and ride in the rodeos. I was a good musician. But I rarely had to take
a book home and was not really challenged until I got to college.
Unbeknownst to me, my father submitted the application for me to attend
Harvard. We went out to the superintendent of schools because Harvard said
I had to take college boards. He had never heard of the college boards.
No one knew of them, and I was the first student ever to take the college
boards from my high school. I learned by this time everybody took them as a
junior, but I was already a senior. So somehow I got into Harvard. I always
dreamed of going to the Naval Academy, since I had grown up in a very
patriotic family. And I did get admitted to the Naval Academy my
sophomore year at Harvard.
I decided to stay at Harvard, and that’s another story in itself, but I was
given a full scholarship by the Navy. I remember probably one of my
proudest moments was my mom pinning on my second lieutenant bars as a
United States Marine, and that has been a good part of my life as far as
developing me as a leader and man.
I served in Vietnam for a year, and then on to Harvard Business School. I
was 28 when I started to work for a Cleveland company. I came to Cleveland
because I married a girl from Ohio. If I took you to this little dirt town I came
59
82
[Vol. 33 No. 1]
from, you would understand why I wanted to be in Cleveland, although I had
a lot of fun growing up in the country.
And in my case, I worked for eleven years for Cleveland companies.
During the last year, I was working out in Solon, Ohio for a company called
Technicare. We were heavily into diagnostic imaging products, digital X-ray,
magnetic resonance, nuclear medicine, and computed tomography, and
Invacare was a little appendage that Technicare didn’t keep.7
Actually, Johnson & Johnson bought Technicare and didn’t want it
either.8 It had been for sale for three years – an orphan no one wanted.9 It had
a minor position in the wheelchair industry.10 I had been thinking about
having my own business, and unfortunately, at age 37, I had testicular
cancer.
I survived that, but at the time I thought I was going to die when I heard
the word ‘cancer,’ but it didn’t happen. I had survived Vietnam and cancer,
and at 39, I decided I wanted to buy this little company, and the company
was for sale for $8 million.11 I had $10,000, and all I needed was another
seven million, nine hundred ninety thousand, simple math.
I put my house and both my cars in my wife’s name, and I invested the
$10,000 in the company. We bought the company for $8 million and
borrowed $7 million. So we had a million dollars of common equity, raised
from friends and soon to be friends and friends of friends I met at the
Harvard Business School Club in Cleveland.
And I borrowed another $140,000 - $40,000 from two friends and
$100,000 from the company, giving me a 15% stake in the company. There
was $10,000 of equity, $140,000 of debt, which made up my 15% of the
million. Then I had to sign a $6.5 million guarantee at the bank. “Big deal,” I
thought, “I will sign that,” since I had nothing to risk.
And then they wanted $2 million of life insurance, and I remember
thinking, “Oh, darn, I can’t get life insurance. I just had cancer.” But then,
interestingly, I got a discount because I didn’t smoke. I was happy about that.
And so we bought the company. I had a partner, J. B. Richey,12 who studied
engineering at Case Western Reserve University. He is the technical brains
of Invacare, and I am the salesman. We used to plot how we could buy it
because we knew we didn’t have much money.
7
See generally Our History, Invacare Corporation, http://www.invacare.com/cgibin/imhqprd/inv_company/company_info.jsp?s=0&area=History (last visited Oct. 12, 2007)
[hereinafter Our History] (brief history of the company).
8
Id.
9
Id.
10
Id.
11
Id.
12
Id.
83
I was unable to get it financed in Cleveland. No one would back me. No
one would back me in Lorain County where the company is. I had to go
outside. I finally was able to get it financed in Chicago. I will tell you a
funny story. During my financing trips, I went to Aetna in Hartford, and I
didn’t raise money, but I came out of the Aetna building, and the sky was
black and the wind was blowing.
I said to the cab driver, “I am from Oklahoma, and I would say you are
going to have a tornado.” He said, “We don’t have them up in this part of the
country.”
I said, “Okay.” So I am driving to the airport, and it is getting darker, and
all of a sudden the wind is blowing like hell, and the front of the window of
the cab pops out. And the cab spun around, and I noticed that the plane that
was on the stand there at the Hartford Airport had flopped over on its side.
We pulled up to a building next to a motel where the roof was gone; there
was a little liquor store and wires and cables all over. So, I was in the only
tornado that Hartford ever had.
I finally got to call my wife from a working payphone, and I said,
“Honey, I am not going to be able to get home tonight. I have been in a
tornado in Hartford.” She said, “Sure you have.” And I said, “Get on the TV
and watch.”
But anyway I was able to raise the money, and the rest of it has been easy.
Buying the company was much harder. When you have no money, buying
something is a lot tougher than running it. And running it has been a lot of
fun and quite easy, but we have had our challenges.
First year sales were only $25 million; we went public in 1984 when we
were at $90 million in sales.13 Today we have 6,200 people and $1.5 billion
in sales.14 Even though our stock has been down lately because of some
challenges, the people who backed me at $0.02 per share have shares that are
worth $25 today.15 It has been up as high as $48, and we will be back there
again.16
But it has been a lot of fun, and I can spend the whole afternoon talking
about it and many of the business challenges that every company has. But
about two months after I bought Invacare, a friend named John Balch, whom
I worked with at Invacare, said, “Mal, I want to buy a company like you did,
will you help me?” And I said sure. John looked around and found a
13
See
generally
Invacare
Corporation,
FundingUniverse
http://www.fundinguniverse.com/company-histories/Invacare-Corporation-CompanyHistory.html (last visited Nov. 4, 2007) [hereinafter Invacare Corporation]..
14
Id.
15
See
generally
Chart:
Invacare
Corp
IVC
(NYSE),
Reuters,
http://stocks.us.reuters.com/stocks/charts.asp?symbol=IVC&WTmodLOC=L2-LeftNav-10Charts (last visited Oct. 12, 2007).
16
Id.
60
84
[Vol. 33 No. 1]
company called Royal Appliance, maker of the Dirt Devil.17 It was the
world’s best-kept secret, this Royal vacuum cleaner; they were all metal and
sold exclusively through vacuum cleaner shops.
We bought it for $4 million and borrowed $3.8. That’s the art of leverage
buying. Use the bank’s money to buy the thing, and you get all the upside.18
If it goes the other way, you lose your $200,000, but the bank, they put up a
lot of risk.19
I said, “John, I will do this for $20,000.” I raised the investor group, I got
the banking, but I didn’t have any money because I just put my $10,000 in
Invacare. So we agreed that I would pay Royal $2,000 a year for ten years,
and I was asked to be chairman of the board. And about seven years down
the road we took the company public, and I got $30 million out. I had made
only seven payments totaling $14,000.
So that was a nice story, and that taught me a lesson about the difference
between liquidity and net worth. Does anyone know the difference? High net
worth is when you are rich but don’t have the money to spend so you can’t
liquefy your net worth.20 So Royal Appliance gave me liquidity, and I was
able to buy some things. Joe Louis said money is not important unless you
want to buy something.21
Then one night I ran into a guy that worked for a company called
American Sterilizer. He was an engineer/scientist type, and he had an idea.
Instead of using ethylene oxide where overnight you sterilize an endoscope
with then current technology, why not come up with a faster sterilizer?22 At
this time, the first patient in the morning got the sterilized endoscope, but the
rest of the patients got a disinfected endoscope during the day.23 He had a
new idea to sterilize the endoscope after each use. His company was not
interested, so he left the company.
And I met him at Nighttown in Cleveland Heights. After my third Jack
Daniels, we decided to back this guy. And we created a little incubator
17
See
About
TTI
Floor
Care
North
America,
Dirt
Devil,
http://www.dirtdevil.com/companyInfo.aspx (last visited Nov. 3, 2007).
18
See generally John Olsen, Note on Leveraged Buyouts, TUCK SCHOOL OF BUSINESS AT
DARTMOUTH, CTR. FOR PRIVATE EQUITY AND ENTREPRENEURSHIP, (2003),
http://mba.tuck.dartmouth.edu/pecenter/research/pdfs/LBO_Note.pdf.
19
See generally id.
20
Cf.
High
Net
Worth
Individual
(HNWI),
Investopedia,
http://www.investopedia.com/terms/h/hnwi.asp (last visited Oct. 12, 2007).
21
See “Money Ain’t Everything”, TIME, Mar. 3, 1947, available at
http://www.time.com/time/magazine/article/0,9171,854656,00.html (quoting Joe Lewis saying
“Money ain’t everything, unless a poor guy ain’t got it.”).
22
See generally Paul Davies, Clinic Infections Put a Sterilizer of Lab Devices Under
Microscope, WALL ST. J., Dec. 24, 2004, at A1.
23
See generally id.
85
company called STERIS Corporation.24 I didn’t have any money because I
put my $10,000 in Invacare, and I owed $20,000 to John Balch. I had just
been elected to the board of a new venture firm here in Cleveland called
Primus Venture Partners, Inc.
I went to Loyal Wilson, managing partner of Primus, and said, “It is a
great idea. You ought to invest in this idea to make a new sterilizer.” Loyal
didn’t think it was a good idea, but he didn’t want to insult me because I was
on his board, so he hired a consultant to show it was not a good idea. Loyal
Wilson hired Bill Stanford, who said not only did he think it was a good idea,
but wanted to run the company.
I think it took $20 million of equity before a dollar came in the door. As
you know, Bill Stanford built STERIS into one of Cleveland’s great medical
device companies.25 The two biggest Cleveland companies in medical
devices in the last 30 years are really STERIS and Invacare.26 I made a few
million out of that one but nothing like I did out of Invacare and Royal
Appliance.
Invacare put some money into STERIS, and that’s how we created our
foundation. Those are some special stories. I have got a lot of other little ones
that aren’t as exciting, but people kept coming to me with opportunities, and
I didn’t have the time to really analyze them because I was running Invacare.
Thus, I hired a young man, Mark Mansour, to look at these things, and
eventually, we would fund deals on a deal-by-deal basis. In other words, I
would find an opportunity and go around and say, “Mr. Jones, would you put
a couple hundred thousand in?”
And I said, “Why don’t we formalize MCM Capital Partners?” We have
raised about $100 million from individuals.27 So now we have the money.
When we find the deal, we can do the transaction and operate sort of beneath
the radar of these big LBO funds, and unlike a lot of LBOs, we have a group
of people that know what to do with it, like Royal.
We feel we can help the entrepreneur by putting the right people on the
board. Bill Stanford is more like I am, a marketing guy, so I put J. B. Richey
on the board, a brilliant scientist, and he helped them develop the product. So
24
Company
Information:
About
STERIS,
STERIS,
http://www.steris.com/about/history.cfm (last visited Nov. 7, 2007).
25
See generally John Mangels & Zach Schiller, Building Up Biotech, THE PLAIN DEALER,
Feb.
4,
2001,
available
at
http://www.cleveland.com/indepth/biotech/index.ssf?/indepth/biotech/more/fs04econ.html.
26
See generally id.
27
See MCM Capital Partners, http://www.mcmcapital.com (last visited Oct. 11, 2007)
(“[A] private equity firm that manages committed capital funds on behalf of institutional
investors and high net worth individuals for investments in businesses”).
61
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[Vol. 33 No. 1]
MCM Capital is an excellent LBO firm here in Cleveland, having doubledigit returns, and continuing to buy companies and restructure them.28
Frequently, entrepreneurs turn their business over to a family member
who doesn’t have the same skills or the same drive.29 And frequently, you
will find the business, maybe a third generation business, where the
entrepreneur dies, he or she turns it over to his son or grandson, and they
become protectors of assets rather than builders.30
So I say, “Here, son, here is $10 million,” and the attitude is “I don’t want
to lose it” and risk very much, so frequently, a lot of these little companies
don’t advance.31 And they get into a situation where the family ends up
having to sell it, and that’s the kind of situation that the leverage firms like
MCM Capital are looking for.32
Recently, I raised $25 million to create a company called MWV Pinnacle
Capital Management (Minorities with Vision) here in Cleveland;33 I invested
the first $1 million. We don’t have enough minority businesses in Cleveland.
There is the President’s Council, an organization of minority-owned
businesses in Cleveland, and I have tried – we raised $25 million, and hired
Eric Von Hendricks to run it.34 He ran Shore Bank prior to MWV; we are
looking and trying to create more capitalism in the minority community.35
28
See MCM Capital Partners Announces Initial Closing Of Second Private Equity Fund,
MCM
Capital
Partners
http://64.233.167.104/search?q=cache:CTF0vOzuhCMJ:www.mcmcapital.com/n_initialclose.
htm+MCM+Capital+Partners+Announces+Initial+Closing+Of+Second+Private+Equity+Fund
&hl=en&ct=clnk&cd=1&gl=us (last visited Nov. 9, 2007).
29
See generally Robert L. Wallace, Preparing a Smooth Exit Strategy, ENTREPRENEUR,
July
1,
2003,
available
at
http://entrepreneur.com/management/familybusiness/successionplanning/article63392.html
(explaining the need for entrepreneurs to properly train family members before they exit the
company).
30
See generally Rhonda Abrams, Strategies: Planning Your Exit Helps You Grow Your
Apr.
27,
2007,
available
at
Business,
USA
TODAY,
http://www.usatoday.com/money/smallbusiness/columnist/abrams/2007-04-27-exit_N.htm
(stating that family members may not be capable of running the company).
31
See generally Wallace, supra note 29.
32
See generally Olsen, supra note 18.
33
See generally Melissa Monroe, Untapped Capital, BLACK ENTERPRISE, available at
http://www.blackenterprise.com/cms/exclusivesopen.aspx?id=455&p=0.
34
The President’s Council, http://www.thepresidentscouncil.com/ (last visited Oct. 11,
2003) (“The organization was established in 1996 to support entrepreneurial and economic
development within the African American community, and to foster strategic alliances with
CEOs of other major corporations…”).
35
Editorial, Quiet Crisis: A Helpful Push, THE PLAIN DEALER, Sept. 24, 2002, available at
http://www.cleveland.com/quietcrisis/index.ssf?/quietcrisis/more/1032859951204630.htm
(explaining that the Minorities With Vision Pinnacle Capital Fund “will help minority
businesses start, expand, launch new product lines or acquire other companies. In some cases,
the fund may itself purchase local firms and install minority management teams.”).
87
We need more of that in Cleveland. Hopefully, some of these people come
back and give back to their communities.
I have invested in Resilience Capital, where my son works, and these
guys buy companies out of bankruptcy and turn them around.36 In one of
their investments, I put in $120,000 and got back $5 million in two years.
In addition, I have been involved with several startups. I have bought and
sold approximately 40 companies. So let me just sort of wrap up by saying:
What does an entrepreneur really enjoy in life? And I think the thing I enjoy
the most is freedom. I don’t have to work for anyone. I am not beholden to
anyone. I don’t have to wonder about getting fired.
Generally, I can do anything I want, go anywhere I want. Freedom to me
is very, very important. And I don’t have to kiss anybody’s tail or tell my
boss how great he is. I don’t have to do any of that, and that’s important to
me. I know that when I worked in industry, I worked for some really talented
people, and I worked for some eggheads. I was not very comfortable telling
the egghead his idea was great. That’s not me. I did very well when I
reported to a great manager and didn’t do well when someone was afraid that
I would discover they weren’t great.
You have to be able to deal with wild net worth swings, and you have to
be prepared to have not every one of your ventures succeed, but that’s where
the tax collector is helpful. So when you lose money, you can offset the
losses against your gains.37
I was at my Harvard College Class Reunion recently. I was the only
businessman on the panel, and our class was asking what we had wanted to
do with the remainder of our lives. I am 66. All the smart guys in my class
went to the Peace Corps, wanted to work for the government, foundations or
teach.” They were going to solve all the world’s problems, you know. And
old Mal, I said, “I have to get a job and pay for my rent” and this sort of
thing. So they asked us what we want to do with the rest of our lives, and the
smart ones said they have no money, $0 net worth. “How will I get financial
security?” The guys like me who went to work; we said, “I want to solve the
world’s problems.” It was complete role reversal.
Perhaps I am
exaggerating, but I wouldn’t be here today if it weren’t for Harvard.
I have funded four perpetual Harvard College scholarships for students
from Oklahoma or Northeast Ohio.38 These students always write me and tell
36
Resilience Capital Partners LLC, http://www.rcpmb.com (last visited Oct. 11, 2007)
(“[A] private equity firm focused on principal investing in lower middle market
underperforming and turnaround situations.”).
37
I.R.C. § 165 (a) (2004) (allowing deduction of any loss sustained during the taxable
year).
38
COMPARATIVE LEGAL ASPECTS OF ENTREPRENEURSHIP IN CANADA AND THE UNITED
STATES CONFERENCE PROGRAM, CANADA-UNITED STATES LAW INSTITUTE 5 (2007),
http://cusli.org/conferences/annual/Conference_Program__f_.pdf.
62
88
[Vol. 33 No. 1]
me how they are doing. I just had a black female from Oklahoma who
became a Rhodes Scholar from Harvard. That to me was so exciting. The fact
that I got to go on a scholarship – my parents had no money – it makes me
feel happy that I can help some of these same kids.
Recently, I was involved with creating what’s called the Marine Corps
Heritage Foundation in Quantico, Virginia. The State of Virginia donated
land to it.39 The Corps really doesn’t have a place to bring it altogether, and
that has been a very fulfilling project – I put the first dollars in and worked
with the commandant of the Marine Corps and other great Marines to bring
this to fruition. There are so many Marines out there running companies, it is
unbelievable.40 I might say that Cleveland’s Al Lerner, one of my great, great
friends, was a Marine.41 And his son, Randy, after Al died, made a major
contribution to this project in his father’s name.42
I created the first entrepreneurship chair in Cleveland at the Weatherhead
School of Management here at Case Western Reserve University, and Bob
Hisrich from Tulsa, Oklahoma, filled the chair.43 Scott Cowan, the former
dean at Weatherhead, brought him here, and we spent a lot of time together.
Bob Hisrich has the number one book in the world on entrepreneurship
answering questions like “How do I write a business plan?”44 I encourage
everyone to buy a copy.
DR. HISRICH: Absolutely.
MR. MIXON: But it is published, and he traveled a lot to Russia, and
taught, not the children but people, how to practice capitalism. The Chinese
haven’t forgotten. The Russians are having a tough time understanding
39
See Marine Corps Heritage Foundation, http://www.marineheritage.org/index.asp (last
visited Nov. 4, 2007).
40
See Military Experience & CEOs: Is There Link?, KORN/FERRY INTERNATIONAL, 12
(2005),
available
at
http://www.kornferry.com/Library/ViewGallery.asp?CID=1741&LanguageID=1&RegionID=
23 (listing CEOs with Marine Experience).
41
Alfred Lerner: Chairman & CEO of MBNA Corporation, THE HORATIO ALGER
ASSOCIATION
OF
DISTINGUISHED
AMERICANS,
http://www.horatioalger.org/members/member_info.cfm?memberid=LER98 (last visited Oct.
13, 2007) (giving the biography of Alfred Lerner).
42
Roll of Honor Donor: Mr. Randolph D. Lerner, Marine Corps Heritage Foundation,
http://www.marineheritage.org/RollHonor_donor_detail.asp?NAV=1&PageFrom=Y&PageVa
l=00001-5930000104978&ROHName=Lerner&ROHFName=&ROHCity=&ROHState=&ROHQLevel=0
(last visited Oct. 13, 2007).
43
Robert D. Hisrich – Weatherhead Faculty, Case Western Reserve University
Weatherhead
School
of
Management,
http://webdev.case.edu/faculty/faculty.cfm?id=5380&view=yes (last visited Nov. 4, 2007).
44
ROBERT D. HISRICH, MICHAEL P. PETERS, & DEAN A. SHEPHERD, ENTREPRENEURSHIP
(7th ed. 2006).
89
capitalism, and Bob can tell you some real stories about his teaching in
Russia. In how many languages is the book now printed?
DR. HISRICH: Nine.45
MR. MIXON: Nine languages. So I was proud I could work with Bob,
and since Bob has moved on to another school – and I will let him tell you
about it later. I have been able to use my philanthropy at The Cleveland
Clinic and the Cleveland Institute of Music. But I have enjoyed the
satisfaction of being able to do those things, and to create businesses. It is a
lot of fun.
I have to say, as I stand up here, I never had to work for a living other
than my eleven years I was working for somebody else. I don’t consider what
I do as work; it is fun. I talk to people that say, “You know, I don’t like what
I do, and when I retire, I am really going to have some fun.”
I said, “Why don’t you do something you like?”
“I am making too much money. I would have to change careers and go
back.” But you know, we are not here on Earth very long. I am happy – I
look forward to every day. When I was a young man, before I had cancer, I
was never happy with the money I made, my position. Cancer really sobered
me up in terms of enjoying every single day. When I get up each day, I am
not afraid to die. I am not saving my life for something else out there.
Someone asked me once if I had a fantasy, and I said I really have this
fantasy that I would like to be able to take a year off, not take any of my
money, anything with me, and just go to a strange city like Phoenix. I have
no money in my pocket. I will look in the jobs-wanted there, and I will get a
job. And I believe I could do it again with no money because I know how to
do it. So to me, that would be my fantasy.
So I am going to open this up for questions here in a second, but I wanted
to read you a little poem that you all read in high school but I think best
described my life, and I have asked my wife to put this poem on my
tombstone. She has already selected our lots out in Hunting Valley.
But it is a poem by Robert Frost, and you have all heard it, but I want to
read it to you because to me it really talks about the entrepreneur. It is called
“The Road Not Taken.”46
I believe you all know it – about the two roads that diverged, and I had
taken the one less traveled by, and that has made all the difference.
Thank you.
45
Robert
D.
Hisrich,
Thunderbird
School
of
Global
Management,
http://www.thunderbird.edu/about_thunderbird/ctrs_excellence/CGE/who_we_are/hisrich_bio.
htm (last visited Oct. 13, 2007).
46
Robert Frost, The Road Not Taken 1 (Bartleby.com, Inc. 1999) (1920), available at
http://www.bartleby.com/119/1.html (last visited Oct. 13, 2007).
63
90
[Vol. 33 No. 1]
DISCUSSION FOLLOWING THE REMARKS OF A. MALACHI
MIXON, III
MR. HERMAN: Well, how about that? Mal, thanks for a wonderful
description of what it means to be an entrepreneur, how you succeed, the
kinds of motivations and luck, I guess, that comes into play. Let’s have some
questions now.
I think we had a lot of interesting comments from Mr. Mixon. The first on
the list is the honorable Henry King.
DR. KING: Well, thank you.
Mal, what I wanted to find out is, when you invest in companies, do you
have any standard data equity ratio that you always target so that the
entrepreneurs have some stake in the enterprise themselves?
MR. MIXON: I am going to answer that question with two parts. My debt
to equity ratio is determined by how much I can borrow. Royal Appliance
actually was an asset-based loan. You have income-based loans and assetbased loans.47 Banks that are interested are willing to lend about 35 percent
on the inventory, about 85 percent on the receivables, and that number came
up to a little more than $4 million.48
And the bank said, “Mal, you got to put something in it.” So the answer
is: I like to leverage as much as I can, put as little equity in as I can because
that’s the risk portion. If you grow the company and succeed, all that profit
goes to you.
Now, the second thing is, I don’t really care about ratios. If I am backing
an entrepreneur, I don’t care how much he puts in but I do care relative to
what he has. If somebody is willing to put in all $20,000 of his net worth and
take a second mortgage, then he becomes a believer in my eyes.
I had a guy come to my house one night, and he is worth several million
dollars. And he had decided he had to start a publication called “MBA.” I
didn’t think there was a market for the publication. I don’t see MBA’s as a
target market. He wanted me to invest in it, and I said, “How much are you
putting in?” He told me $50,000, and I said, “Get out of here. If all you are
going to put in is $50,000, given your net worth, I am not interested.”
So what’s really important is: Is the entrepreneur really committed? So
that would be my answers to this. By the way, MBA made one publication,
which was a beautiful publication; turned out they gave all the advertisers
47
Allen N. Berger & Gregory F. Udell, Small Business Credit Availability and
Relationship Lending: The Importance of Bank Organizational Structure, ECON. J. 1, 22
(2002), available at https://www.federalreserve.gov/Pubs/FEDS/2001/200136/200136pap.pdf.
48
See generally Hilary Rosenberg, Mining the Balance Sheet, CFO MAG., May 2001, at
106, available at http://www.dushkin.com/text-data/articles/29435/body.pdf.
91
free space in the first publication, and that’s the only one ever published.
They lost so much they never published the second edition.
But when you are investing with someone, when you are going to back
someone, what’s important is: Are they committed? Otherwise forget it. It is
not going to work.
MR. HERMAN: Mal, we have these reading materials and the people can
have a look at what’s in this book, because there is some very good reference
documentation. In the tab for the discussion that Mal has been leading us on,
there is an interesting survey, and I wanted to get his comments.
There was a discussion by Transetter, and they research entrepreneurs to
find out what are the factors most critical to business success for fast growth
private companies, and I wanted Mal’s reaction to this. If you look at the last
page of that survey in that tab, it shows the most critical factor in a new fast
growing company is retaining key workers.49 The second most important
factor is hiring qualified workers. And in terms of the ranking of those two
items, they rank well above, well above all of the other factors that go into
business success.50 I wondered what your comments were.
MR. MIXON: I wouldn’t agree with that. I think far and away the most
important principle is the customer and understanding what the customer
really wants and providing what the customer wants. When I bought
Invacare, I spent the first 30 days out in the field interviewing – actually,
Invacare made a standard folding wheelchair – and I went out, and first of
all, they would tell me how screwed up Invacare was.
And I said, “Well, if they were a good company, I could not have
afforded to buy it.” Then they started describing the principal competitor and
how they hated my competitor, Everest & Jennings. They are since bankrupt
but had about 80% market share when I started.51
The Everest & Jennings chairs were institutional, heavy, ugly-looking
wheelchairs.52 I soon learned that people with disabilities were angry
because, in those days, they had no access to society.53
MR. HERMAN: No ramps.
MR. MIXON: Right. So we were fighting legislatively to change it. And
we now make one out of titanium aluminum that weighs 13 pounds.54
49
Trendsetter
Barometer,
Entrepreneur.com
4
(2007),
available
at
http://www.entrepreneur.com/misc/trendchart.pdf.
50
Id.
51
See generally Press Release, Graham-Field Health Products, Everest and Jennings
International LTD. to be Acquired by Graham-Field Health Products, Inc. (Jun. 19, 1996),
available at http://www.secinfo.com/d1112.93.d.htm; see History of Wheelchairs and Power
Add-On
Units,
http://scholar.lib.vt.edu/theses/available/etd-12898174432/unrestricted/literature_review.pdf (last visited Nov. 4, 2007).
52
See generally History of Wheelchairs, supra note 51.
53
Id.
64
92
[Vol. 33 No. 1]
MR. HERMAN: This is new technology.
MR. MIXON: This is all new. We introduced the first microprocessor
computer in the motorized wheelchair market.55 You’re all familiar with
Christopher Reeve. He was a C-1, which is the highest level of spinal injury,
and he used our chairs.56 But every company I buy, I want to talk to the
customer, and I guarantee you, if every one of you went with me, I will come
back with a list of stuff you need to change about the product and the service.
When I entered this business of customized wheelchairs, it took six weeks
to deliver it,57 and today we deliver in five days. We invented one-stop
shopping, which is we brought under the umbrella all these home-care
products.58 So when you go home today, you make one phone call to
Invacare. Customers are what we are in business for, not ourselves. Profits
are a result of achieving excellence.59
Every one of us has a choice: When you choose a wife, a car or house,
you compare. Your job is to make sure that the customer’s choice is what
you have to offer.
MR. HERMAN: But that meant –
MR. MIXON: But give me a second. If you don’t have a customer and
you don’t have a product, sure, you want to have good people, and you have
to have good people and you want to be a good recruiter. We treat our people
very, very well. They are paid well and treated well. We have no assigned
parking places.
We eat in the same lunchroom; have casual dress and direct access to
management. We don’t care if you went to college, whether you have an
MBA, doesn’t matter. It is what you do, and that’s the way the people feel,
and that’s more important to most people than whether they make an extra
$5,000.
MR. HERMAN: When you took over Invacare and saw the need to
respond to the customer’s needs, you have to develop a new product
essentially or change.
54
Invacare
A4
Titanium
Ultralightweight
Active
Performance
Rigid,
http://www.invacare.com/doc_files/P2002_104_TITANIUM_T4.pdf (last visited Oct. 13,
2007).
55
See Invacare Corporation, supra note 13 (Invacare was the first firm to produce a
motorized wheelchair with computerized controls).
56
See, e.g., Kim Palmer, Recharging Invacare, SMART BUS. CLEV., Oct. 2003, available at
http://www.sbnonline.com/National/Article/124/5413/Recharging_Invacare.aspx.
57
See generally id.
58
Id.
59
Cf. Werner J. Reinartz & V. Kumar, The Impact of Customer Relationship
Characteristics on Profitable Lifetime Duration 5 (Insead R & D, Working Paper
2001/108/MKT),
available
at
http://www.caplix.com/pdf/Profitable%20Customer%20Relationships.pdf.
93
MR. MIXON: You have to change what you got because it changes – our
product development cycle is now 14 months and it used to be two years. So
we are trying to be faster in innovation. If you don’t innovate and replace
what you have, your competitor is going to eat your lunch.60
Sometimes the pioneers are the ones that get the arrows in the back,
because the second guy comes in with something that is better. So you have
to keep innovating, and there may be patent lawyers in the audience, but I
think patents slow down the process. They don’t stop anything. J. B. Richey
can design around any patent I have ever seen. We try to patent things. But it
is innovation, being first to market, having the thing you want. Everybody
always wants it to do something more: smaller, cheaper, or another color. We
make 60 different colors in wheelchairs.61
MR. HERMAN: But did you find when you took over the business, you
had the in-house expertise, or did you have to get new people in the process?
MR. MIXON: I took what I had, which was only 300 people. I have 6,200
now. I recruited; I didn’t summarily fire everyone. I had a strange event on
day one. My background is sales and marketing – I had just purchased the
company, and the sales manager had been canned from J & J. He comes in
my office and says, “I want a bonus for the previous year.”
And I said, “That’s somebody else’s responsibility, not mine. I am not
paying bonuses yet.” This was January of the year but he comes in and says,
“I am going to resign in December. I said, “December of this year, 12 months
out?”
And he said, “Yeah.”
And I said, “It is thoughtful of you, but I don’t need you that long.”
He said, “How long do you need me?”
I said, “What time is it? It is 2:00 pm. How about 4:00 pm?”
So I lost my VP of sales, whom I would have fired anyway.
Today we are doing around $6 million in sales per salesperson vs. $1
million in 1979. They are extremely well paid, and nobody can pirate them. I
pay them more than anybody so my competitors can’t pirate them. I want
them to make even more.
DR. BARBER: I enjoyed the Robert Frost analogy at the end, but it made
me wonder if you take the path less traveled with those – all those
entrepreneurial types, it seems to me there must be another cross in the road,
60
See e.g., Maria Vassalou & Kodjo Apedjinou, Corporate Innovation and its Effects on
Equity Returns 3 (1st Annual UBC Finance Conference, 2003), available at
http://www2.gsb.columbia.edu/faculty/mvassalou/CI2.pdf.
61
Cf. Invacare, http://www.invacare.com/doc_files/P1995_66_9000_XT.pdf (last visited
Oct. 13, 2007) (Many different colors and frame options for wheelchairs are available from
Invacare).
65
94
[Vol. 33 No. 1]
at least in Canada, and most of them would at that point take the path well
traveled.
I wondered if you felt here in the United States that you have taken
another step in a path less well traveled. The reason I ask this is because even
amongst entrepreneurs in Canada, to talk the way you do about the customers
does not happen. That’s not a path that is taken.
MR. MIXON: Well, you know, I only know what I know and what has
made me successful. And I can’t say the entrepreneurial path is for everyone.
If I talk about the entrepreneur, the next guy that takes over Eaton
Corporation from Sandy Cutler, he is going to make a hell of a lot of money.
The guy that runs the corporation, they are making huge money. I am sure
I would have been fired at least three times had I pursued that route in my
career because I am just not a good organizational type. I think one in a
hundred new businesses succeed in America.62 I don’t know what the
Canadian ratio is.
Bob, what is the Canadian ratio?
MR. HISTAN: Seventy percent.63
MR. MIXON: Seventy percent. That’s a little off from my statistics, but I
am glad I am under 30, but what is failing?
There is no such thing as failing. I know men and women who tried and
didn’t succeed the first time around. And I was 39, and I said to my wife –
my wife was very supportive of me doing this – I said, “Honey, what’s the
worst thing that happens? I lose $10,000. I know I can get a good paying
job.”
DR. BARBER: And she has a house and car.
MR. MIXON: She still has it.
By the way, you have a great country in Canada. Invacare does very well
there; number one market share in Canada.64 As a matter of fact, Invacare is
now number one market share in Europe, Canada, Australia and starting now
just to market in the Far East.65 We have factories now in China,66 40
factories around the world.67 We market our products now to 80 countries.68
62
PETER F. DRUCKER, INNOVATION AND ENTREPRENEURSHIP 3 (Collins 2003).
See generally Moren Lévesque, UW Researcher Studies Why Some Businesses Succeed,
While Others Fail, U. OF WATERLOO, Oct. 26, 2006, available at
http://newsrelease.uwaterloo.ca/news.php?id=4795.
64
See generally INVACARE CORPORATION 2005 ANNUAL REPORT ON FORM 10-K
CONTENTS, http://www.invacare.com/HQ/EDITORIAL/20060331/2005Form10K.pdf.
65
See generally id.
66
See PUTTING IT ALL TOGETHER, SUMMARY ANNUAL REPORT 2004, available at
http://www.invacare.com/HQ/EDITORIAL/20050408/2004AnnualReport.pdf
67
See generally id.
68
See generally Our History, supra note 7.
63
95
When I began, we sold only in the United States in 1980. We redefined our
company as a world company, not just a U.S. company.
MR. HERMAN: Just can you tell me a little bit about China because it is
something that we have addressed here at the Institute and what’s the proper
China strategy? It is a little bit off topic, but I thought we might address it.
MR. MIXON: I really pride Invacare on being the low-cost producer, and
we are the highest profit company, and we put most of our U.S. competitors
out of business, and suddenly we started seeing imports and knockoffs and
copy cats from China at prices 25 percent below our prevailing prices.69
So we have had to – and probably we are a little late doing it, late in
moving more of our manufacturing to China – we are in a free world
economy. I don’t have time to debate all the rules and whether you are going
to have protectionism, but survival is what it is about. We have a huge
purchasing office in Hong Kong where we procure over $200 million per
year, and I have two factories in China.70
Today about 20 percent of our cost of goods sold come from China, and
within three years, 40 percent will come from China.71 The Chinese
government is more cooperative and capitalistic than Americans. I am talking
about all the red tape you go through trying to get permits, and it is very
easy.
My companies are in plants and parks that are far more attractive than
anything you will see in Cleveland, and my labor rates vary from $30 in
Germany to about $15 in Ohio to about $3 in Mexico down to $0.50 in
China. If you want to know how much you can save, take a payroll and
subtract it. But I have had to give it up in pricing. It has not been for profit
but survival to compete with the Chinese companies.72
MR. CUNNINGHAM: Is any of your Chinese production coming back to
the United States?
MR. MIXON: Oh, yes. It is all coming back to the States or to Europe. It
is a worldwide production operation.73
MR. CUNNINGHAM: What does that do as far as production in the
United States in terms of jobs and things like that?
69
Cf. Pete Engardio & Dexter Roberts, The China Price, BUS. WK., Dec. 6, 2004,
available at http://personal.georgiasouthern.edu/~mmcdonal/the_china_price.doc (China
forcing certain manufactures to compete with lower prices).
70
Cf. Peter Krouse, Opening Plant here is a Walk in the Park, CLEV. PLAIN DEALER, Dec.
11,
2005,
available
at
http://chinaresourcenetwork.com/Plain%20Dealer%20SIP%20article%2005.htm (Invacare has
manufacturing facilities in China).
71
Id.
72
Engardio & Roberts, supra note 69, at 1.
73
Id. at 3.
66
96
[Vol. 33 No. 1]
MR. MIXON: We reduced it and will keep reducing it, and we announced
that publicly.74 But I am just telling you manufacturing is in serious trouble
in this country if you have international competition.75 If you don’t, you
know, that’s fine. But that’s the way it is, and we are in a world business
today.
MR. HERMAN: Well, the hour is upon us as Henry has reminded me,
visually and otherwise. I would like to thank Mal Mixon for an excellent
presentation. So please join me in a hardy round of applause.
74
75
Krouse, supra note 70.
Engardio & Roberts, supra note 69, at 1-3.
PRIVATE FINANCING OF ENTREPRENEURSHIPS: SOURCES
OF PRIVATE FINANCING; GUARANTEES (REQUIRED
PERSONAL OR OTHERWISE); WHEN TO GO PUBLIC (PROS
AND CONS); RIGHTS OF FINANCING PARTIES; DEFAULTS;
CAPITAL FORMATION FOR ENTREPRENEURIAL VENTURES;
TAX CONSIDERATIONS
Session Chair – Michael Robinson
Canadian Speaker – David Woolford
United States Speaker – Morton A. Cohen
INTRODUCTION
Michael Robinson
MR. ROBINSON: I am Michael Robinson. I am pleased to preside here,
which means I do not have to do any hard work. I asked to do this because I
represent the last of entrepreneurial financing lawyers.
When I started practicing in 1966, I did two things: Non-recourse project
financing, mostly for mines, which was inventive in Canada, and IPOs, for
what was then an unusual thing, for the service industry such as radio
broadcasting and insurance brokerages that had no bricks and mortars. In
other words, they were businesses that did not make “things.”
Now, our two speakers today represent the present and the future of
entrepreneurial business financing, and I will briefly introduce them. Mr.
Cohen is going first.
Morton A. Cohen is a closet Canadian born in Montreal, but not as
Canadians are said to be, particularly shy. His bio of many achievements in
Canada and U.S. in finance is almost a page and-a-half, but I am going to
distill it for you. He owns Clarion Capital, which is a small business
investment company, which does private placements in public companies. He
founded Clarion Capital Corporation, which runs several domestic and
offshore hedge funds, achieving a 15 percent overall return since its
inception in 1994. That’s not quite up to Warren Buffet’s return rate I don’t
think, but if you go to the last paragraph of his bio in which he details his
healthcare and life sciences investment activities over the last eight years,
and you will see that he achieved an internal rate of return of over 200
97
67
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[Vol. 33 No. 1]
percent. Now, Warren Buffet has never done that and rarely has any investor
that I know of. His background is a B.A. in Economics from Concordia
University in Montreal, an M.B.A. in Finance from Wharton, and he is a
certified financial analyst.
I hope Mr. Cohen will tell us something about how the local medical
research establishment in Cleveland, which is so well known and primarily
led by The Cleveland Clinic, contributes to his entrepreneurial activities in
this field.
Mr. David Woolford is a closet Yank. He was born in the U.S. and ended
up in Canada. He is a partner at Cassels, Brock & Blackwell LLP, a major
Toronto firm and one of the sponsors of this organization, the Canada-U.S.
Law Institute. He specializes in business law, corporate finance, e-business,
privacy law, and securities law, and especially the development and
financing of high tech companies, including many startups in Canada and
abroad.
Indeed, David just returned from closing a deal in Germany between a
Canadian technology company and a major German partner. He has
published extensively on the subject of emerging developments in
technology law. He is also an angel investor and a member of the Toronto
Angel Group. So he puts his dollars where his legal advice is obviously, and
he knows the entrepreneurial game from the inside out as well as just the
legal aspect thereof.
He is also Chairman and a director of Virox
Technologies Inc., and holds various other private directorships and advisory
board positions.
So without further ado, Morton, would you care to begin?
Morton A. Cohen*
MR. COHEN: Good afternoon. I really cannot thank you enough for the
opportunity to follow Mal Mixon. It is like following Warren Buffet. Let me
just say it is just nice to be here.
I walked in here, and the first couple of words I heard were “disputes,”
and at lunch I heard “conflicts,” and that reminded me of an old story about a
lawyer who goes hunting in rural Tennessee. The lawyer is duck hunting, and
sure enough he shoots a duck, and the duck falls in the farmer’s field. The
lawyer goes up over the fence to get the duck.
The farmer appears, and gets off his tractor and says, “this duck belongs
to me; it is on my land.” The lawyer is absolutely indignant and he says, “I
am going to sue you. I am a very famous lawyer, and I will sue you and take
everything you have.” The farmer looks at him, says, “You know, we have a
Woolford & Cohen—Private Financing of Entrepreneurships
99
way of settling disputes in Tennessee. We have this three-step rule.” The
lawyer looks at him and thinks, “I can take on this old cogger.” So the farmer
then proceeds, and he takes his steel boot and rams it right into the lawyer’s
groin. And then he turns and rams his boot again into the lawyer’s mid drift.
The farmer kicks him in the rear and the lawyer falls into a bunch of cow
pod. The lawyer is absolutely shocked, and he manages to stagger to his feet
and wipes his face on his sleeve, and he says, “So now it is my turn,” at
which point the farmer says, “Yeah, but you can have the duck.”
I want to give you a panorama of American financing that is emerging
today. First of all, let me say that we have financed private companies, and
we spent about ten years in financing startups and developing companies
before we got into private placements. Let me just start with the banking
system.
The first place you go if you are an entrepreneur is a banking institution.
The banking system is different in the United States than in Canada. Canada
has major banks that really control the environment, whereas the United
States has multiple banks and has a variety of loans, and recently a lot of
them have bad credits.
But banks are all the same: they want your right arm and sign. The one
difference in Canada is, if you default, if you screw the bank, you do not get
any more loans. In the United States, if you screw a bank, you can always
move to Wyoming, Florida, or Southern California and start all over again.
So there is a difference in the way banks tend to treat entrepreneurial
investors.
When you get to angel investors – and when I say this, I want you to
know that I have the benefit of being in finance on both sides of the border,
probably equal time in my business career – this country has a tremendous
benefit. Perhaps one of the reasons why it is more entrepreneurial is because
the angel investors have larger pools of capital,1 they are high net worth
*
Mort Cohen joined Clarion in 1981 as chairman of Clarion Capital Corporation, which
was then a closed-end mutual fund investing in public and privately-held small companies
through private placements. After becoming CEO and assuming sole management of the fund
in 1982, he had the distinction of taking the only Small Business Investment Company out of
bankruptcy in the history of the Program. Clarion Capital today is an active Small Business
Investment Company specializing in private placements in public companies. Mr. Cohen
purchased the fund in 1987 and took it private in a leveraged buyout in 1989. In 1994, Mr.
Cohen started Clarion Management Ltd., which managed Clarion Partners, L.P., a domestic
hedge fund, Clarion Offshore Fund Ltd., an offshore hedge fund, and Dynamic Equity Hedge
Fund, a Canadian-based hedge fund. In 2006, Mr. Cohen liquidated Clarion Partners, L.P. and
discontinued managing Dynamic Equity Hedge Fund. He continues to manage Clarion
Offshore Fund, Ltd. The three hedge funds had approximately $140 million in assets at their
peak and generated an approximate 15% return since their inception. Between 1983 and 1989,
Mr. Cohen also managed First City Technology Ventures, a venture fund investing in small
public companies through private placements, for which he achieved an approximate annual
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[Vol. 33 No. 1]
investors,2 and the angel investing area is more pronounced and has more
experience.3 This country has a legacy of speculation. Canada does not have
investment rate of return of 25 percent. Additionally, as chairman and CEO, Mr. Cohen took
Childers Products, a specialty manufacturing company, from $2 million in losses to $5 million
in profits and industry dominance before selling it in 1989 to a New York-based leveraged
buyout group. Prior to joining Clarion, Mr. Cohen operated MAC Management, a Canadianbased mergers and acquisitions consulting practice. Among his clients were large Canadian
companies, such as Reitman’s, Ltd., Hiram Walker, Ivaco Industries, and First City Financial,
Ltd. (the Belzberg Family) for which he researched major U.S. acquisition candidates. Earlier,
Mr. Cohen was president of Yorkton Securities, then an institutional boutique, which is today
one of Canada’s leading securities firms. As such, he was responsible for the firm’s research
department and creation of an institutional research unit. During this time, he was named to
the Canadian Institutional Investor All-Star List in Distilling two years running. Before that,
Mr. Cohen managed research departments and serviced institutional brokerage clients for a
number of Canadian securities firms including: Kippen & Co., which has since been acquired
by Nesbitt Burns and is now the largest Canadian securities firm; Baker Weeks, for which he
was vice president and the premier U.S. institutional salesman; and Merrill Lynch, for which
he was the top performing salesperson in Canada. Mr. Cohen is currently a member of the
board of directors of Cohesant Technologies, Inc. Formerly, he was governor of the Montreal
Stock Exchange (1972-73), a member of the board of governors of the National Association of
Small Business Investment Companies (1990-92), and a member of the boards of directors of
Sanyo-Canada, Adac Laboratories, Abaxis Co., Alexander Energy, DHB Industries, Inc., and
Zemex Corporation. He also served on a Senate committee that rewrote the legislation for the
Small Business Investment Company Program. Mr. Cohen was a member of the Visiting
Committee of the Weatherhead Business School of Case Western Reserve University in
Cleveland, Ohio and a Trustee of The Jewish Federation of Cleveland. He has also been a
major contributor to various Cleveland institutions and the Miriam Home Foundation of
Montreal. Mr. Cohen is Chairman of the Investment Committee of the Jewish Community
Federation of Cleveland, which has over $500 million in investment assets. A Chartered
Financial Analyst, Mr. Cohen holds an MBA in Finance from the Wharton School at the
University of Pennsylvania and a BA in Economics from Concordia University in Montreal.
Mr. Cohen has an extensive background in Healthcare and Life Sciences investments having
focused the portfolio of Clarion Capital in these areas over the past eight years. Among his
present and past investments are Conceptus, Genelabs, NexMed, Inc., Johnson & Johnson,
ARIAD Pharmaceuticals, Cepheid, Intuitive Surgical, Abaxis, ADAC Laboratories, Maxim
Pharmaceuticals, and a large number of other investments spanning the Healthcare field.
During the past five years, Mr. Cohen’s portfolio investments in this sector have generated an
internal rate of return of over 200%. He is also the author of a number of financial articles and
has been published and quoted over the years in Barron’s, Fortune, Business Week, The
Canadian Financial Post, The Wall Street Journal, Crain’s Cleveland Business, and The
Cleveland Plain Dealer.
1
See
generally
David
Rose,
Current
Trends
in
Angel
Investing,
AMERICANVENTUREMAGAIZNE.COM, http://americanventuremagazine.com/articles/223 (last
visited Oct. 19, 2007) (“Angel investments for the first half of 2005 alone totaled over $11
billion” in the United States).
2
See generally id. (“[T]he number of accredited investors who are entering the angel
world is increasing each year by double-digit percentages.”).
3
See generally R.K. Honeyman, The Benefits of Utilizing Automation for Efficient Deal
CAPITAL
3
(2007),
Flow
And
Capital
Procurement,
NUQUEST
http://www.nuquestinc.com/UserDyn/NuQuest/white%20paper%20_3.pdf
(“The
angel
101
the same legacy of speculation. This is a country of the J. Goulds, the Fisks,
the Mellons and the Carnegies.
Angel investing is changing. Groups are becoming more sophisticated.
You have family offices. You have, to some degree, even ethnic partnerships
that are emerging. For instance, in California, there is a strong ethnic
partnership among ex-Indians - I don’t mean Native Indians, I mean Indians
who have immigrated - who tend to finance other Indians.
So you have the emergence of a professional angel class here, whereas in
Canada, I am not sure if it exists, other than Calgary and the far west, where
you have a large number of oil people who deal with finance companies.
In the United States we have less Government intervention that sustains
entrepreneurship than in Canada,4 but we do have something called the Small
Business Association (“SBA”), which guarantees bank loans.5
The SBA provides guaranteed loans to corporations,6 the government
carries the banks 85 percent or 50 percent,7 the latter being the norm because
there is too much red tape to try to get the 85 percent loan. But the SBA
program has been very good in terms of financing small entrepreneurs.8
How did the venture capital start in the United States? It started with the
Small Business Investment Company (“SBIC”) program in 1958.9 It nurtured
investor marketplace is robust, with substantial amounts of capital looking to find homes for
worthy ventures.”).
4
See generally Sound too Good To Be True? It Is!!, Fort Worth Business Assistance
Center, http://www.fwbac.com/index.asp?content=325 (last visited Oct. 25, 2007) (describing
that opportunities for federal assistance in small business is limited).
5
See Loan Fact Sheet, United States Small Business Administration,
http://www.sba.gov/idc/groups/public/documents/wa_seattle/sea2007loanfactsheetmar22.pdf
(last visited Oct. 14, 2007) (explaining the process of Small Business Administration’s
guarantee loan program).
6
See SBA and EX-IM Bank Co-Guarantee Program, United States Small Business
Association,
http://www.sba.gov/idc/groups/public/documents/sba_program_office/oit_sba_im_desc.pdf
(last visited Oct. 14, 2007) (“Any sole proprietorship, partnership or corporation, which
operates as a going concern and meets SBA’s definition of an eligible small business
concern,” can receive guaranteed loans).
7
SBA’s Role: Guaranty Percents, United States Small Business Administration,
http://www.sba.gov/services/financialassistance/basics/sbarole/serv_7a_guarantyperc.html
(last visited Nov. 3, 2007).
8
See Will Kester, SBA-backed loans: Good for entrepreneurs?, HELIUM,
http://www.helium.com/tm/466307/small-business-assoc-backed (last visited Oct. 22, 2007)
(“The idea of SBA backed loans is a great concept in a country that encourages entrepreneurs,
and it has allowed many start-up ventures that would have never had the chance to succeed
without it”).
9
See Venture Capital Policy Review: United States 3, (Organization for Economic Cooperation and Development, Working Paper No. 12, 2003) available at
http://www.olis.oecd.org/olis/2003doc.nsf/809a2d78518a8277c125685d005300b2/c1a8e0ab8
1412decc1256d89004fd86f/$FILE/JT00148189.PDF (“The US government played a
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[Vol. 33 No. 1]
venture capital, and produced the original venture capitalists. Today SBIC
has made approximately 3,674 investments and has raised approximately
$2,797 billion in equity and debt capital investments.10
SBICs either pay interest to the Government,11 or alternatively, the SBICs
partner with the Government.12 I was involved in writing the legislation for
it. Up until this legislation, 44 percent of all the SBICs failed.
The Government supports entrepreneurship, but entrepreneurship does not
necessarily ensure success. Venture capitalism in this country has a stellar,
but varied record. If you go back to 2000, there were 7,812 venture capital
deals and these deals raised approximately $104,379 billion.13 This number is
staggering.
The year 2000 was absolutely a stellar year. Since then, we have had a
decline, but recently, there has been a turn around. In 2004, we had
approximately 3,072 venture capital deals with the average deal amounting to
$7 million.14 The total amount of investment was short of the record set in
the year 2000, but it is growing recently. The number of venture capital deals
in existence has grown.15 Currently, you have approximately 915 venture
capital firms, 16 the number of first-time venture capital funds is
significant role in the development of the venture capital market, starting in 1958 to encourage
the private disbursement of large amounts of capital through the Small Business Investment
Company (SBIC) program and various technology development schemes”).
10
See generally An Introduction to the U.S. Small Business Administration (SBA), Office
of
Entrepreneurial
Development,
available
tat
http://www.sba.gov/idc/groups/public/documents/sba_homepage/serv_abt_overview_english.
doc (last visited Oct. 14, 2007) (“In Fiscal Year 2006, the SBIC Program produced $2.9
billion in equity and debt capital investments during the year. The program’s licensed SBICs
made approximately 4,000 investments in approximately 2,121 different small businesses”).
11
See generally Finding Money! Small Business Investment Corporations, Abc’s of Small
Business, http://www.abcsmallbiz.com/bizbasics/moneymatters/finding_money.html (last
visited Oct. 14, 2007) (explaining the differences between SBICs and local banks are that local
banks do not have the government investing with them).
12
See generally The U.S. Small Business Investment Company Program: History and
Current Highlights, National Association of Small Business Investment Companies,
http://www.nasbic.org/about/sbic_history_highlights.cfm (last visited Oct. 15, 2007) (“The
SBIC program is a unique partnership between the public and private sectors”).
13
See Eric Pakurar, The New Next: Proceed With Caution, MEDIADAILYNEWS, April 17,
2007, http://blogs.mediapost.com/mdn_commentary/?p=937 (comparing venture capitalism in
2000 and 2006).
14
See Industry Statistics, National Venture Capital Association, (2007),
http://www.nvca.org/ffax.html (depicting venture capital statistics for years 2004 to 2007).
15
See Pakurar, supra note 13 (“According to the National Venture Capital Association,
some $26 billion was invested in 2006 through VC channels; more deals were done than in
any year since 2001”).
16
See MONEYTREE SURVEY, NATIONAL VENTURE CAPITAL ASSOCIATION,
PRICEWATERHOUSECOOPERS AND THOMSON FINANCIAL, Q2 2007 US RESULTS 1 (2007),
https://www.pwcmoneytree.com/MTPublic/ns/moneytree/filesource/exhibits/2Q07MoneyTree
103
approximately 40,17 and capital assets under management is approximately
$285 billion.18 So we raised a lot of money. You can see 2000 was one heck
of a vintage year.
And because of what happened, because so much money went in to
venture capital, the rates of return went down. So as a consequence, we had a
number of years where it just took the industry a long time to build up.
Consequently, early stage investing has diminished dramatically, and
alternatively, expansion development and later stage investment has become
more popular.19 It has become harder to raise early stage money, even in the
technology sector.20 It has become more onerous. On the whole, venture
capitalists are seen as more professional than angels, as we said here before,
and to some extent angels are regarded as dumb money and venture
capitalists as smart money. Venture capitalists, as we all know, tend to want
more corporate governance and control in certain cases.21 There are always
constraints, but nevertheless, the venture capital industry has expanded over
the years.
The number of dollars going into various segments of the industry has not
changed significantly. In 2005, computer software was invested in
significantly,22 while biotechnology received a reasonable amount of
_Report.pdf (stating that venture capitalists have invested $7.1 billion dollars in 977 deals).
17
See generally Emily Mendell, Matthew Toole & Sandy Anglin, Venture Capital
Fundraising Activity Slows in 3Q 2007, NATIONAL VENTURE CAPITAL ASSOCIATION, THOMSON
FINANCIAL 2 (2007) http://www.nvca.org/pdf/Q307VCFundraisingFINAL.pdf (showing the
number of new funds in 2007 is 40).
18
See Scott Evans, Executive Vice President TIAA-CREF, Saving Investors Money:
Reducing Excessive SEC Fees, Testimony before the Subcommittee on Capital Markets,
House Financial Services Committee 1 (Mar. 7, 2001), available at
http://financialservices.house.gov/media/pdf/030701ev.pdf (“$285 billion in assets under
management”).
19
See generally Bill Snyder, Venture Capital Firm Swarming to Late-Stage Investment,
THESTREET.COM (2004), http://www.thestreet.com/tech/billsnyder/10149100.html (explaining
that many venture capital firms are preferring to invest in last-stage investment opportunities).
20
See generally John Cook, Venture Capital: Angel Investors Guarding Money,
SEATTLEPI.COM, March 8, 2002, http://seattlepi.nwsource.com/venture/61378_vc08.shtml
(stating that companies are unable “to attract financing from early-stage angel investors and
lacking the customers and revenues necessary to bring in venture capitalists.”).
21
See generally Franklin Allen & Wei-ling Song, Venture Capital and Corporate
Governance, WHARTON 18 (2002), http://fic.wharton.upenn.edu/fic/papers/03/0305.pdf (“It
appears that governance matters for the level of venture capital activities across countries.”).
22
See Lawrence M. Rausch, Venture Capital Investment Trends in the United States and
Europe,
NATIONAL
SCIENCE
FOUNDATION
(1998),
http://www.nsf.gov/statistics/issuebrf/sib99303.htm (stating that in 1995 and 1996, “software
was far and away the most favored technology area for venture capital investments.”); see
generally ALLEN & SONG supra note 21, at 18 (“In the US venture capital is primarily
associated with high technology industries.”).
70
104
[Vol. 33 No. 1]
investment,23 energy received a modest amount of investment,24 and
communications received the most investment.25 One of the things that you
have to understand about the venture capital industry is that as an
entrepreneur your chances of raising money if you live in northern California
are better than if you live in Cleveland. If you look at the percentage of
money, 35.7 percent of all the venture capital deals were done in northern
California.26 That is a staggering amount.
The northeast followed closely, with approximately 27 percent.27 The
reason why the venture capital industry matured in California was due to
Stanford University in the south and Berkeley University in the north. These
two great learning institutions fed into the venture capital industry.
While you had the biotechnology industry emerging on the West Coast
because of these great educational institutions, the same thing was happening
in the northeast. The Boston area, needless to say, has a large number of
major learning institutions. In order to engender venture capital, there needs
to be a cooperation of learning institutions. This is where ideas and science
are born.
The number of venture capital exits has changed dramatically. As a
private entrepreneur, when you have taken venture capital money, you may
wonder how you will exit. One way is to raise additional money the
traditional way, with an initial public offering (“IPO”). This has changed
dramatically because the merger and acquisition route has become the major
route. As a result, the number of IPOs has not gone up; it has gone down.
And you are going to find out why. There is something that is going on in
the United States that does not get much publicity; there is very little written
in the press. Entrepreneurs basically do not really understand when they raise
money what the exits are, and that the exits are changing dramatically.
We have a limited number of small IPOs in this country because the
method of changing and financing small companies is changing dramatically.
It is amazing that so few people have picked up on these changes. Companies
23
See generally Rausch, supra note 22 (“Medical/health-care-related companies have also
attracted large amounts of venture capital.”).
24
See United States Top Target for VC Firms Worldwide, DELOITTE & TOUCH LLP AND
NATIONAL
VENTURE
CAPITAL
ASSN.
4
(2005),
http://www.nvca.org/pdf/VC%20Survey%20PR%20FINAL%206-22-05.pdf (“Twelve (12)
percent of all VCs surveyed said they are currently focusing on investments in
energy/environment.”).
25
See Rausch, supra note 22 (stating that the telecommunications companies have
“attracted large amounts of venture capital”).
26
See MONEYTREE SURVEY, supra note 16, at 6 (“Silicon Valley continued to garner the
bulk of venture capital dollars, capturing more than 35 percent of the $7.1 billion distributed to
US based companies.”).
27
See id. (“[The] New England Region continued to show a robust market for venture
activity.”).
105
are now doing private placements.28 These private placements were
marketing institutions,29 and so this market is growing.30
You have had an increase in 2005 of something like 39 percent. This
market raised $27.83 billion, and that is small compared to the venture
capital industry, but that is up from $20 billion the year before. This market
was almost nonexistent. There were many small companies founded by
entrepreneurs who needed exits, and who were not doing the traditional
IPO.31 Rather, they do private investment in public entities or PIPE
financing.32
These small venture capital backed companies are going one step further
and doing reverse merges. Investment bankers in the United States are very
creative. These bankers took these venture capital backed companies, and
instead of going public through an IPO, found a shell and backed the existing
company into it.33 When these companies go up, you have raised PIPE
money.
These new exit strategies for venture capital backed entrepreneurs have
caused a huge bonanza for the legal profession. Companies like Shulte Roth
have emerged as major players in the legal business. There are also major
angel players who are literally unknown, like Feldman, Weinstein, Ballard
and Spawn. These companies – Schulte Roth did 60 deals worth $26 billion.
As a result, many legal firms are receiving great legal fees. It also has
become a new enterprising field for the legal profession.
By the same token, there are some small venture capital groups that are
specialized in businesses. For example, a firm like Iroquois Capital did 117
28
See Darrell Zahorsky, Financing Your Business by Private Placement, ABOUT.COM,
http://sbinformation.about.com/cs/creditloans/a/prplacemt.htm (last visited Oct. 14, 2007)
(“Private placements are an attractive alternative for growing companies.”).
29
See id. (explaining that private placements offer a private market for “business financing
without the constraints of taking a company public and conceding control.”).
30
See Zahorsky, supra note 28 (stating that private placements are an “attractive
alternative”).
31
See generally Jennifer Nasri, Weekly Corporate Growth Report, Firms are Turning to
Private Placements over IPOs for Funding, THE WALL ST. J., May 22, 2000, available at
http://findarticles.com/p/articles/mi_qa3755/is_200005/ai_n8879800 (explaining that firms are
turning to private placements over IPOs for funding).
32
See generally Equity Financing Strategies for Micro-Cap and Small-Cap Publicly
Traded
Companies,
Friedland
Capital
Inc.,
2
(2006),
available
at
http://www.friedlandcapital.com/PDFs/Equity%20Financing%20Strategies%20for%20Micro%20and%20Small-Cap%20%20Companies.pdf (explaining that private investment in public
equities, or “PIPE” programs, is one strategy for private placement financing).
33
See generally Stocks-Reverse Mergers, The Investment FAQ (2002), http://investfaq.com/articles/stock-reverse-merger.html (describing how reverse mergers generally
function).
71
106
[Vol. 33 No. 1]
deals last year worth $1 million.34 This has become a tremendous method of
financing, and the rates of return have been substantial.
We have done a lot of medical deals, which do better in the public market,
not through the local banks. These medical deals have had substantial rates of
return because we were buying later stage companies at cheaper multiples
than the venture capitalists further along the technological curve. For
example, in Intuitive Surgical, which is a robotic method of surgery, our
stock went from $2 to $120. These companies could not get financing in the
conventional sense. In the beginning this path to financing was not crowded,
so the rates of return were substantial. This has changed because there are
new players. This is no longer a niche business. Mutual and venture funds are
becoming involved.
We do a number of cross border energy deals. We look for Canadian
companies that have expertise in the mining and energy fields and who also
have U.S. properties. Using an SBIC, we are limited to companies that are
either U.S. or have the majority of their assets in the United States. As a
result, we back a number of Canadian companies. These small Canadian
companies have a lot of expertise in either the mining or energy fields that
you do not find in the United States. We were involved in 13 private
placements of public companies last year, and we did two private groups.
Investment bankers have developed another method of financing, called
Specialized Acquisition Companies (“SPAC”).35 SPACs benefit the
entrepreneur in numerous ways. SPACs are blank check companies, which
the investment community has invented.36 SPACs have three layers of
promoters: the investment banking business; the directors and super
managers who raise the money, sit on the board and guide the strategic
34
See generally Press Release, Sagient Research Systems, PlacementTracker Publishes Q3
2005
PIPE
Market
League
Tables
(Oct.
25,
2005)
available
at
http://www.sagientresearch.com/pt/News/PR10.25.05PTPublishesQ32005League1.htm
(“Iroquois Capital, L.P. topped the list of most active institutional investors during the third
quarter of 2005.”).
35
See generally Kit Roane, Business Buffet, U.S. NEWS & WORLD REPORT, Jan. 22, 2006,
available at http://www.usnews.com/usnews/biztech/articles/060130/30spacs.htm (describing
special purpose acquisition company); see generally Mike Bernstein, Geller & Company,
SPACs and Reverse Merger Offer Alternatives to Traditional IPOs, FINANCE AND
ACCOUNTING VIEW 1 (2006), http://fandaview.com/archives/pdf/06Winter_CapitalTrends.pdf
(“[With] the market for smaller initial public offerings relatively quiet in recent years, some
companies are turning to alternatives such as Specified Purpose Acquisition Corporations
(SPACs).”).
36
See generally Richard Siklos, Former Media Executives Give New Life to ‘Blank Check’
Corporations, THE NEW YORK TIMES, April 13, 2007, at 1, available at
http://www.nytimes.com/2007/04/23/business/media/23blank.html?_r=2&oref=slogin&oref=s
login (describing that special purpose acquisition companies have a catch, where “investors do
not actually know what their money is going to be spent on when they buy shares – hence the
‘blank check’ designation given by the Securities and Exchange Commission.”).
107
management of the company; and then there is the actual company that will
be taken over, which is generally a small entrepreneurial company that wants
to get a higher multiple for their stock.37
In 2005, SPACs raised $1.2 billion in financing.38 The prospectuses of
these companies, like Cincore and Merrill Lynch, will likely double or
probably triple this year. One of these deals went for $276 million.39
Another trend in financing entrepreneurs is private equity. I am not sure
what private equity really means, and I am not sure what the difference
between private equity and leverage buyout is, but anyway, private equity
raised $160 billion in financing in 2005,40 and $190 billion in 2006.41 The
numbers are so staggering it is hard to believe. There are also leveraged
buyout funds. They have raised $197.6 billion in financing.42 I am not sure
what the crossover is. This is venture economics, and Money Tree combines
these statistics, so the crossover is reasonably close.
How does private equity help entrepreneurs who want to exit? Well, the
company is taken private, it is re-circulated, and it is sold back to the public
at a higher price. 43 Hertz is an example.44 Sooner or later this method of
37
See generally Karen Richardson & Peter Lattman, SPAC Investors are Asked to Buy In –
on Faith, THE WALL ST. J., Feb. 1, 2007, available at http://www.postgazette.com/pg/07032/758636-28.stm (describing generally how special purpose acquisition
companies function).
38
See generally BLANK CHECK COMPANIES – AN EMERGING INVESTMENT VEHICLE, MAXIM
GROUP http://files.irwebpage.com/shipping/articles/BLANK_CHECK_COMPANIES.pdf (last
visited Oct. 14, 2007) (“2006 was the year in which the blank check market flourished, with
over $2.9 billion in 37 transactions raised, a 50% increase from 2005 with $1.9 billion raised
in 28 transactions.”).
39
See generally Richardson & Lattman, supra note 37 (“[In] November, fruit-juice seller
Jamba Juice Inc. went public on the Amex after it was purchased by Services Acquisition
Corp., another SPAC, for $265 million.”).
40
See MONEYTREE SURVEY, NATIONAL VENTURE CAPITAL ASSOCIATION,
PRICEWATERHOUSECOOPERS AND THOMSON FINANCIAL, PRIVATE EQUITY GOING PUBLIC 13
(2006),
https://www.pwcmoneytree.com/MTPublic/ns/moneytree/filesource/exhibits/Global_PE_2006
.pdf (“[The private equity f]unds raised soared during 2005 to US$ 160.5 billion”).
41
See Brian Gormley, Venture Capital Investment Surges In 2006 To $25.7B, THE WALL
ST. J., Jan. 22, 2007, available at http://www.atvcapital.com/news.php?id=460 (“[P]rivate
equity funds of all types – venture capital, buyout, mezzanine, distressed debt, secondary
funds, and funds of funds – raised a record total of $215 billion in 2006, according to the
Private Equity Analyst, a newsletter published by Dow Jones. Of that total, $25 billion went
into venture capital funds, the newsletter reported this month.”).
42
See Shane McDaniel, 2006: Truly a Year for the Record Books, PIPER JAFFRAY (2007),
http://www.piperjaffray.com/pdf/monitor031407.pdf (“Accommodating debt markets were not
the only factor driving LBO activity to record levels. Buyout shops raised more than $197.6
billion in capital.”).
43
See generally Grace Wong, IPOs: Don't fear 'The Flip', CNN MONEY, May 16, 2006,
http://money.cnn.com/2006/05/15/markets/ipo/private_equity/index.htm (“Private equity firms
generally use their own money and borrowed funds to turnaround distressed companies. When
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exiting will end, because the multiple is high. The rule generally is that, since
the leverage is about five-and-a-half times to six, 45 you have to find the
difference by some other financing. Currently, $250 million deals are going
for a domestic buyout purchase price multiple of 7.5, so the leverage is
somewhat smaller.46
Entrepreneurs today can raise financing in many places. This is a seller’s
market. So, if you have a great company, you are golden. We have not seen
this trend in a long time. There are liquidity opportunities out there. The
problem sometimes is that can be extreme in either direction, so we have got
to sit and hope this economy continues and that credit problems will be
resolved.
CANADIAN SPEAKER
David Woolford*
MR. WOOLFORD: Good afternoon, ladies and gentlemen. I listened with
interest as my friend Mr. Morton told the story about the lawyer and the
farmer. I do a lot public speaking, and I normally try to dispel the widely
held notion of the countless number of lawyer jokes that people always bring
up. It is not true. There are only two. The rest are all true stories.
I have the benefit of not only being a lawyer but also being an investor,
and I would like to approach my remarks today from that perspective. I will
a firm has been overhauled, it's common for the investors to either sell the company to a
corporate buyer or take it public.”).
44
See generally Ford Completes Sale of The Hertz Corporation to Private Equity Group,
PRNewswire,
http://www.prnewswire.com/cgibin/stories.pl?ACCT=104&STORY=/www/story/12-21-2005/0004237949&EDATE=
(last
visited on Oct. 21, 2007) (stating that Ford completed a sale of Hertz to a private equity
group).
45
See generally Mitchell Presser, Private Equity & Leveraged Buyouts, 25th Annual
Institute on Federal Securities (Feb. 7-9, 2007) 12-13,
www.westlegalworks.com/presentations/fedsec/presserprivate.pps (showing average debt
multiples and equity contributions spanning from 1996 to 2006).
46
See generally id. at 13 (showing that up to $250 million-dollar deals in 2006 had 7.6
domestic buy out purchase price multiple).
*
A partner in Cassels Brock’s Business Law and Entrepreneurial Business groups, Mr.
Woolford specialized in business law, corporate finance, e-business, privacy law, and
securities law and has published extensively on the subject of emerging developments in
technology law. In addition to his busy law practice, Mr. Woolford is an active angel investor
(member of the Toronto Angel Group), is Chairman and director of Virox Technologies Inc.,
and holds various other private directorships and advisory board positions.
109
also try to bring an inspirational perspective like Mal Mixon, and then delve
into and build upon, the profound remarks of Mr. Cohen.
If I can see a show of hands, who knows whom Zack Johnson is? Zack
Johnson is one of the little guys. He is an entrepreneur, and he just beat Tiger
Woods to win the Master’s. The majority of the pro-golfers that go on the
pro-tour toil in relative obscurity. They are in a constant fight in trying to
secure sponsorship financing. These relatively obscure pro-golfers do not
have the name recognition of Phil, Tiger, and Arnie such that everybody is
jumping at the chance to be associated with it. This is true about all
entrepreneurs. They do not have the money or the profile of the Intels,
Ciscos, RIMs, Googles and the You Tubes of the world. These well known
companies have investment bankers, merchant bankers, and traditional
bankers jumping at the chance to do financing for them.
These unknown entrepreneurs have an insatiable need for capital in order
to grow their businesses, in order to demonstrate traction, to gain market
acceptance, to gain market approval, to penetrate the market, generate
customer orders and customer sales. They have needs for continuous
improvement in R & D, to continue to out perform and outpace the
competition. This insatiable need can be a real chicken and egg dilemma,
because they do not have the necessary organizational money, and the
financiers will not finance them until they become a success. In other words,
they will not finance these unknown entrepreneurs, until they actually have
orders in hand, or actually have demonstrated that somebody wants to buy
their product and buy it in sufficient quantities, so that the yields and returns
are impressive and attractive. So, there is a fear among these entrepreneurs
that they will lose everything. The constant fears are the inability to make
payroll, sending the work force home, having to make payroll deductions,
having to pay rent, the remittances, the statutory remittances for taxes and
workers’ compensation and other levies and assessments that have to be
remitted to the local government. What can these entrepreneurs do? They
will have to go to the landlord again with hat in hand and see what they can
work out. Will the landlord take shares of the company? Another problem is
not being able to meet the supplier’s terms on a regular basis. So it is a real
constant dilemma. It is a real constant struggle for entrepreneurs in order to
be able to attract that capital.
Zack Johnson has a green jacket and he is a Master’s champion. He can
write his own ticket for the next ten or fifteen years, and that is what
entrepreneurs in the tech and other emerging industry areas are striving
towards: getting their company names known. Entrepreneurs want their
companies known so that they can go out and attract sufficient capital on a
regular basis to grow so that they can become the next RIM or You Tube.
I want to discuss the different types of financing, many of which are
similar to the ones in the United States, but that represent opportunities at the
73
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49th parallel for both domestic companies, U.S. companies, and other
companies abroad. A couple of speakers have already touched on angel
investors, so I will not go into more detail. I will note, however, that in
Canada, the primary source of funding for companies that are looking for
their initial seed rounds in the million-dollar range, are angels.47 There are
very few venture capital firms in Canada that have seed or commercialization
funds.48 There are a few. But when you get into the real criteria, many of
them have criteria that make it not pre-revenue. It is not really startups they
are interested in. The criteria constitute a risk profile allocation or
assessment, and when you actually get into it, although they may publish
criteria that suggests they will invest in that space, the number of
opportunities or the number of instances where they actually do is a lot less
than what one would initially believe.
There is also private equity venture capital, which, like in the United
States, is really just a subset of private equity that focuses on a higher risk
profile.49 Again, there are a lot of venture capitalists. I think a comment was
made earlier about the labor sponsor investment funds, and I have many of
those clients and have done many deals where they have invested in clients
of mine. They have represented a good source of funding for Canadian
businesses over the years, but this is changing, and you are starting to see
more private VC funds arise.50 So, there is a proliferation of more VC funds
into Canada to fill the gap.
I am glad Morton touched on the SPAC program. I am not that familiar
with the SPAC program, but I will have a deal in that area soon. I have also
been extensively involved in a program similar to SPAC that our venture
established a few years ago called the Capital Pool Company program
(“CPC”).51
47
See Expert Panel on Commercialization, Government of Canada (2006),
http://strategis.ic.gc.ca/epic/site/epc-gdc.nsf/en/tq00023e.html (explaining that “much of the
investment for early-stage firms is informal (personal savings, friends, family members and
angel investors)” in Canada).
48
See generally id. (“[The a]verage venture capital investment in a U.S. company is nearly
four times that invested in a Canadian company.”).
49
See generally Fraser Forum: Venture Capital: High-risk, High-return Financing, The
Fraser
Institute,
http://oldfraser.lexi.net/publications/forum/2000/07/section_04.html
(explaining that venture capital is high risk, but also has high return financing).
50
See generally About Garage Canada, Garage Technology Ventures Canada (2006),
http://www.garagecanada.com/about (“One of Canada’s newest private, institutionally-backed,
early-stage venture capital funds, whose close ties with Silicon Valley and other emerging
global clusters provides a unique strategic perspective on business cycles, market trends, and
technology that we bring to our portfolio companies.”).
51
See generally Capital Pool Company Program, TSX Venture Exchange,
http://www.tsx.com/en/pdf/CPCBrochure.pdf (last visited Oct. 16, 2007) (“The CPC program
introduces investors with financial market experience to entrepreneurs whose growth and
111
In a CPC program, you establish a blind pool, set up a public company
with a good board of directors and strong management team with a pool of
capital,52 and then go out and find a meritorious target company, and then
you essentially do a reverse takeover and take it public on the venture
exchange.53 A case study is a solar tech company that we are bringing public
here in Canada, which I will talk about in a minute.
Similar to in the United States, there are different types of debt financing
alternatives available to entrepreneurs. Traditional debt, or bank debt, is very
limited in terms of its access to most entrepreneurial companies because
these companies typically do not have assets to put up as collateral.54
Companies that are fortunate enough to get a credit line, it is probably in the
quarter million-dollar range at the maximum, which really is quite limiting
and puts further constraints on these companies and their ability to grow
dramatically like the founders and entrepreneurs want to see it. There are also
some venture debt players.55 A client of ours, an innovation fund, has done
quite well, but when you look at the profile of the businesses they invest in,
the businesses are the traditional, rust bucket, bricks and mortar types. Our
clients are not really investing in entrepreneurs, because these traditional
businesses have a lower risk profile, and they have guaranteed returns, or as
much guaranteed returns as they can.
Trade financing is available in some instances, but again, it requires the
entrepreneur to have a stream of revenue.56 For the companies that are
ramping up in order to gain orders, gain customer acceptance, and gain
demonstrable traction in the marketplace, this form of financing is typically
limited.
development-stage companies require capital and public company management expertise.”).
52
See generally id. (“Unlike a traditional IPO, the CPC program enables seasoned
directors and officers to form a “Capital Pool Company” with no assets other than cash and no
commercial operations, list it on TSX Venture, and raise a pool of capital.”).
53
See generally id. (“The CPC then uses these funds to seek out an investment opportunity
in a growing business. Once the CPC has completed its ‘qualifying transaction’ and acquired
an operating company which meets Exchange listing requirements, its shares continue trading
as a regular listing on the Exchange.”).
54
See generally Expert Panel on Commercialization, supra note 47 (“[M]uch of the
investment for early-stage firms is informal (personal savings, friends, family members and
angel investors)”).
55
See generally EDC’s Invests CAD 10 Million in Venture Debt Fund to Benefit SME
Exporters,
Export
Development
Canada,
(2006),
http://www.edc.ca/english/docs/news/2006/mediaroom_11687.htm (describing a 10 million
dollar investment “in the WF Fund III Limited Partnership, [which is] a $125 million [venture
debt] fund targeting companies in sectors with high export and growth potential.”).
56
See
generally
Who
We
Are,
NORTHSTAR
Trade
Finance,
http://www.northstar.ca/whoWeAre.php (last visited Oct. 16, 2007) (describing a publicprivate partnership, “offering [trade] financing to credit worthy buyers of eligible Canadian
goods and services.”).
74
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From an equity investment point of view, I want to discuss the key
integral aspects that prospective financiers – prospective investors – look for.
One aspect, especially from an angel perspective, is the initial valuation of
the company. As I tell most of my clients, the price has to feel good. It has to
be a price that is compelling enough to cause a particular investor to write a
check. If the investor is going to take a pass, it is likely not because they do
not necessarily like the opportunity, like the space, or like the quality of the
talent and the technology, but because over time they do not feel that they
can garner returns that are sufficient enough either for their own personal
investment habit or for, in the case of funds, the stakeholders who are
expecting a certain rate of return.
Another aspect to look at is what other investors have taken a pass on.
And there is a reason they have. Bay Street is not the size of Wall Street. It is
still a fairly small community, and a lot of the groups like to co-invest. They
like to syndicate their investments. They like to do that because, one, they
like to share the risk allocation, and, two, they like to share and trade the
benefits of the due diligence responsibilities, given the relevant strengths of
each organization. If another investor has had an opportunity to invest and
has passed, there is something typically wrong with the investment. There is
some hair on the deal. As I say, it may be too highly priced, or maybe the
management team does not have the credibility that the investment populous
believes is necessary to drive that particular business, or their technology
may not be attractive enough. It may also be a small-medium sized business,
that is not going to garner sufficient returns to attract the excitement of
people with money, both in the private equity and public markets. We have
seen that with You Tube, and some of the companies that Nortel and Cisco
have bought, that these companies have home run potentials in terms of
multiples. Well, these are getting multiples of 10, 30, 50, a hundred times; it
is tremendous.
There is proliferation in the Valley. The old Internet and web 2.0 funders,
including the Sun Microsystem founders, are all into huge clean tech funds
with money flowing into the solar technology and wind technology.57 Money
is flowing into environmental issues and biodiesel. A lot of the alternative
fuel and alternative energy sectors are attracting considerable interest and, as
we heard some comments earlier about, responsibilities. There are many
57
See generally ERIC MARTINOT, RENEWABLES, GLOBAL STATUS REPORT (2005), available
at http://www.worldwatch.org/brain/media/pdf/pubs/ren21/ren21-2.pdf (“About $30 billion
was invested in renewable energy worldwide in 2004…. The fastest growing energy
technology in the world is grid-connected solar photovoltaic (PV), which grew in existing
capacity by 60 percent per year from 2000–2004, to cover more than 400,000 rooftops in
Japan, Germany, and the United States. Second is wind power capacity, which grew by 28
percent per year, led by Germany, with almost 17 GW installed as of 2004.”).
113
corporations that are striving, especially in the more traditional businesses, to
modify their businesses in a way to demonstrate that they are doing things to
help the environment. Certainly, in the emerging, and in the entrepreneurial
area, there are some tremendous opportunities both for the entrepreneurs and
for the financiers in making investments in these environmental areas.
At this point, I would like to turn to a case study of one company that I
have been involved in and of which I am the chairman. Virox is a company I
established with a friend of mine who was a senior executive at Bausch &
Lomb. Together, we raised a million dollars in love money, or family angel
financing, as I heard somebody refer to it earlier.
You cannot pickup the paper, or listen to the news these days, without
hearing about another threat of the pandemics. For instance, the bird flu or
the avian flu – there is always news about another outbreak in the Middle
East or another outbreak in Britain. Virox has an accelerated hydrogen
peroxide program.58 It is the technology of choice on most cruise ships
worldwide, to fight the Norwalk virus, which many or all of you have heard
about.59 Think back two years ago with the SARs epidemic in Ontario. The
accelerated hydrogen peroxide technology was exclusively recommended by
the Ontario Government,60 which is unheard of. Governments never,
certainly not in our country, recommend a particular product. Usually, there
will be a suite of products or family of products that is recommended. But
because Virox is unique and has the only accelerated hydrogen peroxide
technology out there, the Government of Ontario put in a million dollar order
to outfit every worker on their ambulances and in their hospitals and daycare
facilities when the SARS outbreak was at its zenith.61 In the fall of 2006,
58
See Virox Technologies Inc., http://www.virox.com/ (last visited Oct. 16, 2007) (“Virox
Technologies Inc. has pioneered the broader acceptance of Hydrogen Peroxide based products
with a patented technology known as Accelerated Hydrogen Peroxide (AHP). AHP is a
synergistic blend of commonly used, safe ingredients that when combined with low levels of
hydrogen peroxide produce exceptional potency as a germicide and performance as a
cleaner.”).
59
See generally Susan Candiotti, Sailing the Sickening Seas, CNN.COM, Dec. 2, 2002,
http://archives.cnn.com/2002/TRAVEL/12/02/sick.ships.wrap/ (“The Norwalk virus is one of
the most common causes of gastrointestinal illness and tends to strike people in confined
spaces…. Outbreaks occur regularly on land and cruise ship outbreaks occur several times a
year…”).
60
See Memorandum from Malcolm Bates, Director, Emergency Health Services Branch to
Municipal EMS Directors and Managers (March 27, 2003) available at
http://www.virox.com/pdf/MinstryofHealthSARS_Vers1_1.pdf (“Following the transport of a
patient with suspected SARS, EMAs and Paramedics must decontaminate the vehicle,
stretcher and any equipment used during the call. It is recommended that Virox-5TM, an
accelerated hydrogen peroxide base formulation, be used as the disinfectant of choice for this
purpose.”).
61
See generally Kate MacNamara, Germicide Maker: Virox, Winning in the Battle Against
SARS, NAT’L POST, Apr. 7, 2003, available at http://www.virox.com/outbreaks/04_07_03.asp
75
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[Vol. 33 No. 1]
Virox won the prestigious Canadian-American Business Achievement Award
in partnership with their largest trading partner and strategic investors,
JohnsonDiversey, Inc., out of Wisconsin.62
You may be more familiar with their retail sister company, S.E. Johnson.
S.E. Johnson has a host of retail products, and they have been a team
strategic partner and investor of Virox since 2001.63 I do not have a Robert
Frost poem like Mal Mixon had, but I want to make my last point with a
statement from the President and CEO of Virox, which is, “For
entrepreneurs, stay the course. Don’t get off focus.” Entrepreneurs try to be
too many things to too many people. Know your core competencies. Virox’s
core competency is something I have already described and it is a pretty
compelling mission statement. Infection control is at the heart of everybody
these days and Virox could have done many other things. However, this is
what Virox chose to do, and it has been a huge success.
There have been some worldwide partnerships that Virox has developed.
As I mentioned Steris is in the high level – the endoscopes and the
emergency cardiac wards of many hospitals.
Virox early on was the first foreign operation that received EPA approval
for an Anthrax technology during the bioterrorism postal system problems.64
It was a spray that was developed to be used throughout the U. S. Postal
system to help deal with the pandemic.65
(“[W]ith the outbreak of severe acute respiratory syndrome, or SARS, reaching crisis levels in
Toronto, the firm's disinfecting wipes are fast becoming a must-have commodity. Orders at the
Mississauga, Ont.-based firm have more than doubled over the past couple of weeks as a result
of the deadly new strain of pneumonia.”).
62
See Canada-US Partnership a "Clean" Sweep for 2006 Business Achievement Award,
CANADIAN
NEWSWIRE,
Oct.
23,
2006,
http://www.newswire.ca/en/releases/archive/October2006/23/c3426.html (“The Canadian
American Business Council…. has selected Virox Technologies Inc., of Oakville, Ont., and
JohnsonDiversey Inc., of Sturtevant, Wisconsin to be awarded the prestigious Business
Achievement Award for their collaboration in developing and distributing, a safe and
environmentally friendly hydrogen peroxide-based disinfectant.”).
63
See Press Release, Virox, Johnson Wax Professional Becomes Global Leader in
Accelerated
Hydrogen
Peroxide
Technology
(June
13,
2001),
http://www.virox.com/news/06_13_01.asp (“Johnson Wax Professional has acquired the
exclusive rights in the I & I market to the Accelerated Hydrogen Peroxide (AHP) technology.
Additionally, it intends to purchase a minority stake in the Canadian company that invented it,
Virox Technologies Inc., developing a relationship that will eventually bring the use of AHP
across the globe.”).
64
See Memorandum from Marianne Lamont Horinko, Assistant Administrator, Office of
Solid Waste and Emergency Response to Stephen L. Johnson, Assistant Administrator, Office
of Prevention, Pesticides and Toxic Substances (Jun. 25, 2002), available at
http://www.virox.com/pdf/JohnsonWaxCrisisExemption.pdf (authorizing exemption and
describing conditions).
65
See generally id. (describing use of the spray by the United States Postal Service).
115
Time is kind of tight, so I will quickly run through my remaining slides,
but I thought this slide would be of particular relevance and of interest to the
entrepreneurs in the crowd. This slide sets out a chronology of how Virox
has grown in terms of funding.66 As I mentioned, in July of 1998, we put
together a million-dollar seed round.67 We had to bulk up that seed, with a
rights offering a year later. We secured some bank financing, but again, it
was more in the quarter million range. So it was not that significant to grow
the company. One of the elements that was very significant was that we
entered into these various partnership arrangements, including R & D
contracts, and it was integral for the large partners, whether it was the
Pharmas or the JohnsonDiverseys or the other partners. These large partners
had to fund the research, the tailoring of our crown jewels into applications
that were going to fit into their particular industry and into their distribution
and food chain. We also did a funding round in D.C. in May 1999, which
amounted to $2.5 million.68 We also entered into the big alliance with
JohnsonDiversey in 2000.69 Then Virox turned the corner, and started
generating pretax flow, started to significantly enhance the bottom line so
much so that in the last couple of years, we bought out all the seed investors
and our venture capitalists, which is a unique story. You do not hear about
many tech companies that can do that. This year Virox is trending towards
close to $17 - $18 million on the top line, and $6 or $7 million on the bottom
line. The margins are significant because 90 percent of the product is water.
And the arrangement with Steris has not been completed yet. They are in the
middle of the throws of their FDA submissions.
The EPA registrations have started to come through with
JohnsonDiversey. Most of these figures in Canada and Europe and the Far
East do not even include the biggest market in the world. To give you a quick
idea of how the valuations have shot up, if there were a 2007 bar graph, the
66
See David Woolford, “Private Financing of Entrepreneurships: The Ongoing
Challenges” – Comparative Legal Aspects of Entrepreneurship in Canada and the United
States,
http://cusli.org/conferences/annual/presentations/4WOOLFORD__PrivateFinancingbyEntrepr
eneurships_Apr1207.PPT (last visited Nov. 7, 2007); see also Morton A. Cohen, Private
Financing
of
Entrepreneurships:
Sources
of
Private
Financing,
http://cusli.org/conferences/annual/presentations/4_COHEN____Private_Financing_of_Entrep
reneurships.ppt (last visited Nov. 7, 2007).
67
See generally MacNamara, supra note 61 (“In 1998 [Mr. Pilon] was a vice-president for
eye care giant Bausch & Lomb Canada. Long a ‘thwarted entrepreneur,’ a lawyer contact put
him in touch with local chemist, Michael Rochon. Mr. Rochon had a formula for accelerating
the germ killing action of hydrogen peroxide but no business plan. Mr. Pilon conceived a plan,
and bought Mr. Rochon's firm, M&R Chemical. On the strength of Mr. Rochon's formula, Mr.
Pilon cobbled together $3-million in seed money.”).
68
See generally id. (describing total seed money obtained).
69
See id. (“JohnsonDiversity [sic] even took a 10% equity stake in the company.”).
76
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[Vol. 33 No. 1]
bar would be much higher than the value of the seed shareholders and
venture capitalists a couple years ago.
I will quickly touch on equity investments. The main agreements are
subscription agreements. We set out the deal terms, the representations and
warranties – which should be a full spectrum of the due diligence – and we
set out the various remedies. We heard speakers talk earlier about limitations
and baskets, and those are the things you want to make sure you have an
experienced lawyer to talk to about. In a shareholder agreement, it is
important to put in things to deal with preemptive rights, anti-dilution or full
ratchets, and drag-along, tag-along, piggyback, board provisions.
This is the essence of what I do and the essence of the legal practice
surrounding equity investments in private companies. It is important, as an
entrepreneur, to make sure that you have experienced counsel, not just a
lawyer who is very good in what he or she does, but one that knows the
industry, because there are a lot of unique elements to venture capital
investing and entrepreneurships. So, if the lawyer does not play, day in and
day out, in the industry, then the lawyer will not be able to properly counsel
the client.
There are pros and cons in going public. Virox is a keen example where
we set up and operate like a public company already – compensation
committees, governance committees, audit committees, and regular reporting
to stakeholders and to banks. We have a data room that impresses investment
bankers and other prospective partners.
I mentioned the CPC program. I will quickly touch on it. We just
announced a press release last week. We are bringing the first non-North
American, non-resource issuer to go public on the Toronto Stock Venture
Exchange.70 It is a German solar tech company.71 Germany is universally
regarded as the world leader along with Japan.72 I’ve visited several times
now. Almost every second home, barn, and commercial facility has solar
panels. It is a green environment. This is a testament to the quality of the
70
See generally MarketWire News Releases, Eminence Capital I Inc. Announces Executed
Letter
Agreement,
HOUS.
CHRON.,
Apr.
5,
2007,
http://markets.chron.com/chron?GUID=1662999&Page=MediaViewer&Ticker=ECI
(describing plans to list a German solar power company on the Toronto Stock Venture
Exchange).
71
See generally id. (describing plans to list a German solar power company on the Toronto
Stock Venture Exchange).
72
See generally Robert Collier, Germany Shines a Beam on the Future of Energy, SAN
FRANCISCO
CHRON.,
Dec.
20,
2004,
http://www.sfgate.com/cgibin/article.cgi?file=/c/a/2004/12/20/MNGRAAEL4B1.DTL (describing Germany as “the No.
1 world producer of wind energy, with more than 16,000 windmills generating 39 percent of
the world total, and it is fast closing in on Japan for the lead in solar power.”).
117
program – here is a world leading company that is a real success in its own
backyard coming to North America to establish operations here.
We see daily in the papers about wanting to establish solar parts. The
LPA and government have brought in new incentive programs to help us
establish solar technology.73 It bodes well and provides for some
opportunities cross-border between Canada-U.S. We are bringing this worldclass technology from another jurisdiction, into North America, while at the
same time going public and having access to the public markets here.
DISCUSSION FOLLOWING THE REMARKS OF MORTON A. COHEN
AND DAVID WOOLFORD
MR. ROBINSON: Well, Henry and everybody else will be pleased to
know that we have 22 and-a-half minutes left for questions, which is terrific.
I would just like to say one thing before we do questions.
MR. WOOLFORD: Let me just ask one thing about SPACs. I recall, and
maybe it was more than five, ten years ago, there was a similar type of
program in the U.S., which initially garnered a lot of interest, but then I think
it garnered some bad press as well. Either they were not making a lot of
investments or the investments they were making were less than sterile
quality and caused a lot of dissatisfaction, or caused the program to run into a
lot of lack of interest because of that.
MR. COHEN: I will go back to my initial statement – that investment
bankers in this country are extremely creative. They have come up with a
different structure, which precludes these blank check companies from just
making any old acquisition. The way this thing works is that the money is
raised on certain conditions. One of those conditions is that 85 percent of the
funds go into escrow, at which point you have 18 months to make an
acquisition, supposedly within the domain of your prospectus. If 80 percent
of the shareholders vote against this, they cannot approve the acquisition. If
somebody wants to get their money out after the 18 months, they can get
their money out of that program, minus the 15 percent that the investment
bankers get.
So the structure is different, and it is supposed to be more protective.
There are also warranties that go into these deals, and interestingly enough,
the warranties are at the issue price and sometimes less than the issue price. It
is not all worked out.
MR. ROBINSON: Dr. Barber had the first question, I believe.
73
See generally Government Incentives, The Canadian Solar Industries Association,
http://www.cansia.ca/government.asp (last visited Oct. 16, 2007) (describing Canadian
Federal, Provincial and Municipal incentives for the installation of solar technology).
77
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[Vol. 33 No. 1]
DR. BARBER: David, help me understand why the venture capitalists in
Virox would want to get out of such a successful story?
MR. WOOLFORD: That is a very good question, Doug. And the fact is
that they did not want to get out. I was with a company called Canadian
General Capital, a very successful company, much more so in the larger
investments. We were the only investment in their microcap that actually
made money, and they invested about $2.5 million, and we returned about
$5.6 million. So, the venture capitalists did well from 2000 to 2005, but they
had two main stakeholders: The Power Pension Fund and the Hydropension
Fund and HOPF, the Hospital Pension Fund. And when the power generation
facility in Ontario split into three, they essentially disbanded the source of
funding for this particular venture capital fund and were ordered, over a span
of two or three years to liquidate the funds.
So, Virox was the venture capitalists’ last investment, and they would
have loved to have held on, but it was not large enough for the pension funds.
Either it would have been split 50-50 and then distributed right to the funds,
or as we wanted to do, have a buyout. This was a good question, because if
they were still around, I am sure they would still want to be in as an investor.
They did not have any rights, which was quite unique, but at the same
time, we could only buy them out if they agreed to our price. It was a good
return for them, and since they were in liquidation mode, they let us in.
MS. LILLEY: This is a question for Mr. Cohen. I wondered if you had a
view as to the structure auction market that the investment bankers seem to
have created, as well as some of the other things you created.
MR. COHEN: That is a product I really don’t know that much about. And
I really do not want to comment because I have not been involved in it. What
I wanted to touch on, because I think it is interesting, is that we have another
development in the American scene. We have these Chinese companies
going public in the United States by using a shell vehicle and becoming a
U.S. company where the stock is only traded in the United States.
Similarly, in Canada, you have many Chinese companies that are now
traded only in Canada and have become Canadian companies. I do not know
what this does to entrepreneurs in the United States and Canada. I will say
that it diverts money out from an entrepreneurial company here to the
Chinese companies.
This market is really growing. I am going to China in four weeks, and I
believe that the number of companies that you are seeing in Canada are the
smaller kind, and in China they are getting larger companies.
MR. WOOLFORD: I have been working, as I mentioned, on a program to
bring companies from Germany public in Canada for the last two years. The
real driving force is the international banking accord that many of the
119
European countries entered into, called Basel II,74 in the last year or two,
which significantly restricts access to capital in German companies unless
they are public.75 The problem is that the only exchange that is worthy to
note in Germany is the Frankfurt Exchange, and you essentially have to be a
company that has a market capital of $1 hundred million Euros or above in
order to be able to garner interest and go public on that exchange.
By taking them public on the Venture Exchange in Canada, you can apply
for an inter-listing on the Frankfurt Exchange and secure it that way without
having to meet the significant monetary criteria that many or most of those
companies can’t meet and will never be able to meet. So it is a very attractive
feature that way.
MR. ROBINSON: Why do they not list on the AIM in London?
MR. WOOLFORD: The AIM is probably the largest competitor to the
Venture Exchange. The AIM is at least three times more expensive and has
been fraught with some problems. There have been some success stories.
Sandvine Waterloo, which was a spin-off from Pick Stream, sold out to
Cisco at a hugely significant multiple in the half billion-dollar range, they
went public on the AIM about 12, 18 months ago.76 They had $15 million on
the top line, and a $3 million loss on the bottom line the first day, and their
market was doubled.77 They have recently started taking off again, and they
are starting to get significant traction in the marketplace.
I was trying to steer our chief officer to at least consider AIM for Virox,
but he does not want to be a public company. We believe our exit will be
through our strategic partners. AIM was garnering significant interest and
some significant multiples, and I was telling management of Virox to at least
explore it because it could represent some considerable liquidity. But, the
chief officer just has no interest in being a public company.
MR. ROBINSON: Well, if there is no hand up for a moment, I will just
make a brief comment about the AIM. Our office does quite a bit of work in
the mining game, and we find a lot of our mining clients - Canadian mining
clients - who would seemingly be interested in the Toronto listing, which
74
See generally Basel II: Revised International Capital Framework, Bank for International
Settlements, http://www.bis.org/publ/bcbsca.htm (last visited Oct. 16, 2007) (describing the
framework of Basel II).
75
See generally Basel II: International Convergence of Capital Measurement and Capital
Standards, Bank for International Settlements (2004), http://www.bis.org/publ/bcbs107a.pdf
(establishing higher risk ratings for corporations that are not public).
76
See
generally
About
Sandvine,
Sandvine
Inc.,
http://www.sandvine.com/about_us/default.asp (last visited October 16, 2007) (describing
Sandvine’s listing on the Toronto Stock Exchange (“TSX”) and London Stock Exchange
“AIM”).
77
See generally Stock Market Quotes: Sandvine Corporation, TSX Group,
http://www.tsx.com/ (enter “SVC” in Get Quote box) (last visited Oct. 16, 2007) (showing
performance of Sandvine stock since its listing in October 2006).
78
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[Vol. 33 No. 1]
traditionally was one of the best exchanges in the world for mining
companies. Rather, they wanted to list on the AIM. So we have to do a joint
venture with an AIM expert.
MR. WOOLFORD: I would love to have that capability in-house to
advise our clients to consider a venture exchange or another listing, but as I
said, I have not had anybody that wanted to explore that option. I think it is a
tremendous competitive advantage for your firm and it certainly shows a lot
of foresight.
MR. ROBINSON: They have that wonderful tradition in England where
they have regular principles, the main principle being if you do not behave,
you will not be spoken to at the club.
MR. WOOLFORD: One of our CPC clients from Montreal has a really
neat idea. There is a lot of technology being developed these days in waste
management systems, particularly the systems that apply significant amounts
of heat to change the waste, whether it be energy or other types of materials,
in order to re-circulate it back into the environment. This client had an
abortive, and a very distressing experience with the AIM, and it has cost
them $900,000, and they are just starting to return from it. I am not sure if
they had the best banking advice on the investment side, and perhaps were a
bit naive in some other things. Nevertheless, it is like trying to take a
company out and doing a full blown IPO, whether it be in Canada or the
U.S., and then finding out that either the story was not well received or
market conditions changed, and you are faced with significant dollars.
That is where something like the CPC program or the SPAC program has
a lot of advantages that can dispel, or temper, those negatives.
MS. LUSENBURG: Some of the comments this morning about socially
responsible investing and ethics in the context of the entrepreneurial
community, I think it was Doug Barber that said the cost of governance, legal
barriers, or compliance is significant when you are small operations. That is a
problem. You do not have time for a lot of lawyers and people running
around putting the right structures in place. So you are perceived to be under
the coalition of good governance and it is an issue that increasingly comes
forward. Do you have good principles, ethics? When you are an
entrepreneur, a little guy, how do you deal with that, and with your clients?
How do you bring that to the point of maturing? They have the right process
but do not have the luxury or the vigor to do what they want. They are in a
Catch-22 because you may not be attractive, and from my perspective, we do
not do a lot of venture fund investing, but those are issues we look at. How
do you get them there?
MR. COHEN: I could answer, but quite briefly and I am sure if it was
addressed, I think the major thing that they are looking at is management. I
do not quite agree with Mal Mixon. You have to look at the management and
look at the integrity of management, and you have to decide whether it has a
121
social conscience. Can you make management have social conscience? That
depends on the board of directors. I think the end result is that you will have
a responsible management and entity.
MR. WOOLFORD: I would add from a professional advisory perspective
that you can if you are prepared to put in the time. It is certainly a hallmark
of my practice to help coach and advise these companies, whether I am an
advisory board member or board member, I am spending a lot of time –
beyond billable hours – and generating considerable legal fees, so the return
is more than rewarding, because I believe in these companies, and many of
them have turned out to be very good success stories. You really have to
invest in the relationship, even if it means using your own personal time.
Picking up on the point that Morton mentioned, if you are dealing with a
company that has management with unquestionable integrity, sound
management, good strategic vision, and for which you cannot guarantee a
rate of success of more than 50 percent. They will be a success, then you can
distill those values, and you can work with them and spend the time and help
make that part of the culture. You are not sort of docketing and charging
them for all that because you are essentially enhancing your own client base
as well.
MS. DOBREA: Question for David, what was the origin of the
technology for your Virox company? What role did intellectual property
play, particularly patent, if any?
MR. WOOLFORD: That’s a very good question, and it is actually a very
interesting and somewhat anxiety-ridden story. I first met the mad scientist.
He is no longer with the company, but on the venture capital round, he and
his wife got $500,000 paid to them, which is almost unheard of, so it was a
good deal. Over the course, they received more than a million dollars so they
did quite well. I first met him through a contact at the Royal Bank, and he
had heard that a fellow had few hundred thousand dollars on deposit. The
company must be doing pretty well. You should go talk to him about being a
client.
When the banker first went to see him, he hated bankers, and when I first
went to see him, he hated lawyers. It took many greasy spoon restaurants and
breakfasts and many conversations to get into his comfort zone, and then he
said he was being courted by a group that he called the piranhas that wanted
to buy him out, and ultimately, I introduced him to Randy, and he took a
shine to Randy.
Randy wrote a business plan, and then the three of us got together, and we
received a million dollars. Life was good, and we went to the venture capital
financing and got him a half million dollars, and he was going to be the chief
science officer. No sooner had the ink dried and the deal closed – all of a
sudden he decided he wanted to run the company again and did not care what
79
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[Vol. 33 No. 1]
the agreement said and basically wanted his gas card back. We had some
interesting issues and had to ultimately iron them out.
Coming back to your question, he would not let anybody see the
technology. In retrospect, we should have gotten access to the technology
and done a technological assessment, but other than to show Randy all we
had was four or five patents and several in the hopper. It was like your
grandma’s favorite muffin mix, and you had four, five, or six different
ingredients, all of which you could go to your kitchen or anybody’s kitchen,
and you would all have those ingredients. It was unique, because of the way
they were mixed and matched and how they were applied and at what
temperatures. We think that he just fell on it. We were mortified because
there was a paper that was published in a journal that looked like it came out
about the same time that we first applied for the patent. We had to go to the
publisher, and we had to get evidence and affidavits with the actual time
issues. You know, the typical way the press comes out, they will say January
of 2007, but the thing actually was December something, and it became
really critical.
The other reason we think he just happened on it is because there is a
group in Ontario called Ortech, which was a government funded research
development agency. At this agency you could bring certain products, and
you could get subsidized testing. This guy was a mad entrepreneur because
he wanted to develop a liquid detergent that could compete against Tide.
They priced it out and figured it was $25,000. A few weeks into the test, they
called him up and said we have done half the test and your product has failed
miserably against Tide, and did he want them to continue. He decided not to
continue, but he was just the kind that would tinker, and we think that
ultimately he arrived at something, which spawned into a multi-billion dollar
business.
It is a goodwill story, but when I look back at it and look at the risk
profile, that if we were not able to secure the patent or if it turned out he had
pilfered some of those ingredients, we could be out of business and would
have been out a lot of investment money. It worked out for the best, but when
you look back and say should I, as a lawyer, have done something
differently, he never would have allowed us in. Had we not insisted upon
that, we never would have done the deal. We would have walked and done
something else.
I think it was lockup with Mal. There is some luck involved, but certainly
since then, there has been a lot of value and top notch management and
direction.
MR. COHEN: I have a question for the panel. One is, I do not think, and
it has not been mentioned, what are the status of flow-through shares and
flow-through vehicles available in Canada?
MR. ROBINSON: They are still around.
123
MR. COHEN: The second thing is, maybe with Canada, is the
immigration policy. It has now been the source of a lot of creativity in
entrepreneurship, and it is distinct from policies that we are not developing.
MR. WOOLFORD: Michael, you are the most esteemed member on our
panel, so I will turn to you quickly on this question.
MR. ROBINSON: Quickly then, as you know, we do not have
immigration quotas. We have a point system that is based on a number of
things, including language skills, educational levels and ability to contribute,
et cetera.
We do find that we are getting good quality immigrants. When Selma and
I were practicing together years ago, a wonderful Russian immigrant – who,
in effect, invented liquid ice – allowed certain prospective partners to come
in and look at the technology. They all signed non-disclosure agreements,
and then we found that they had taken out 14 patents in Japan based on his
stuff. Fortunately, we caught them, and they agreed to assign the patents
back.
Obviously, this can be a huge problem unless you have your patent base
registered all over the world. This was a Japanese partner, and he did not
register in Japan, and they just scooped him.
To answer the first question, flow-throughs are still around. I am certainly
not a tax lawyer, but I know that people are trying to sell them to me all
through December. It is like a trust or a partnership where the profits all flow
directly to the investor, the shareholder. They are usually accompanied by
wonderful incentives, in order to stimulate mining exploration, oil, gas in the
far north. It was good in the old days but not so much any more.
MR. COHEN: Well they get a better tax break.
MR. ROBINSON: Oh, yeah, sure.
MR. COHEN: That is the incentive.
MR. ROBINSON: What occurs is that the government subsidy flows
directly through to you as the shareholder so you could invest $10,000 and
get a $12,000 tax write-off.
MR. WOOLFORD: One last comment around this German company, the
solar tech company, although the volumes are not big enough yet, but with
the Kyoto Accord and the carbon credits, we have been looking strategically
and possibly a flow-through investment that includes the share and portion of
the carbon credit that this company can develop.
MR. ROBINSON: Great idea. Sell them in China. Thank you very much
panelists.
80
GOVERNMENT ASSISTANCE TO ENTREPRENEURSHIPS: ON
LOCAL, STATE/PROVINCIAL, AND FEDERAL LEVELS
Session Chair – Ron A. Straatsma
Canadian Speaker – John Connell
United States Speaker – Gilbert B. Goldberg
INTRODUCTION
Ron A. Straatsma
MR. STRAATSMA: Well, good afternoon, everyone. My name is Ron
Straatsma, and I will be your moderator for Session 5.
I am the Managing Director of the State of Ohio’s Canadian Office based
in Toronto, and for your information, you may note that the State of Ohio
operates eleven international offices with Canada, being officially opened
way back in 1990 at the advent of the original Canada-U.S. Trade
Agreement. This afternoon we are featuring our panel on government
assistance to entrepreneurships, talking about government supported –
various levels of support from government, and today we have two speakers
to help us go through that process.
The first speaker is Mr. Gilbert Goldberg, who is the director of the U.S.
Small Business Administration, Cleveland District Office, locally based. As
the District Director, Gilbert is responsible for the administration of a
business portfolio of some 6,400 loans with a total book value of some $604
million.
He has oversight of the Ohio Small Business Development Center and
seventeen sub-centers and the coordination of five chapters of SCORE,
which is a volunteer organization that provides free business counseling. Gil
also serves as national SBA representative under the agency’s lender liaison
program for Key Bank and National City Bank.
And since his appointment as District Director in 1994, the office has
focused its attention on putting the customer first and reducing red tape. In
terms of the results of that, the bottom line focus on the customer has enabled
Gil’s office to outpace the nation in loan growth, and it did so over the last
five years.
125
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[Vol. 33 No. 1]
The District in 1999 also developed a campaign that enabled it to achieve
record loan growth for minority-owned entrepreneurs, and in 2000 the
Cleveland District Office developed a unique initiative for the economic
revitalization for the City of Youngstown and did so by combining SBA
resources, Project Sector Banking in the City of Youngstown.
Before coming to the SBA as District Director back in 1994, Mr.
Goldberg spent 20 years in commercial banking of which the last ten were
devoted to mid-market and entrepreneurial business development in Northern
Ohio. He holds a Bachelor’s Degree in Foreign Service from Georgetown
University and Master’s Degree in Business Administration from the
University of Notre Dame, and he resides in Shaker Heights. So, Gil?
Gilbert B. Goldberg∗
MR. GOLDBERG: Thank you, Ron, for the introduction. I don’t have a
Power Point presentation today. I will just come up here and talk a little bit if
you don’t mind. If you are wondering why I don’t have a Power Point
presentation, I don’t believe in Power Point presentations. I was supposed to
go second, and the other panel member came up to me and said “Gil, would
you mind if you go first? We can’t find my Power Point.” Now you know
why I don’t believe in Power Point presentations.
I will try to make this as interactive and dynamic as possible, even though
we don’t have a Power Point.
One of the things I was wondering is why Henry King called me and said
“Gil, can you be on this panel for the Canada-United States Law Institute?”
And I thought maybe he was interested in my son who is an attorney in New
York rather than myself, and then I started to look through the sessions for
∗
As District Director, Gil Goldberg is responsible for directing the activities of 11
permanent SBA employees; the administration of a business portfolio of over 6,400 individual
loans for a total of more than $604 million; oversight of the Ohio Small Business
Development Center and 17 sub-centers; and the coordination for five chapters of SCORE, a
volunteer organization that provides free business counseling. He is also responsible for the
marketing efforts of the two SBA sponsored micro-lenders in the District as well as the
delivery and oversight of the Agency’s 8(a), SDB, and HUBZone government contracting
programs for small business. Gil also serves as the National SBA representative under the
Agency’s Lender Liaison Program for Key Bank and National City Bank. In addition, he was
a member of the Agency’s Goals Team for four years. Before coming to the SBA in 1994, Mr.
Goldberg spent 20 years in commercial banking. Mr. Goldberg holds a bachelor’s degree in
Foreign Service from Georgetown University and a master’s degree in Business
Administration from the University of Notre Dame.
Goldberg—Government Assistance to Entrepreneurships
127
today, and I saw “Session 1: The Importance of Entrepreneurship to
Economic Growth,” “Session 2: Creating Entrepreneurships,” “Session 4:
Financing Entrepreneurships” and so on. All the sessions had the word
“entrepreneurship” in it, and I thought to myself that’s why we are here. You
can’t think of entrepreneurship in the United States without thinking of the
United States Small Business Administration and our programs.
Basically, we have four programs that entrepreneurs can use, and you in
the room can also take advantage of, whether you are an entrepreneur, a
lawyer, an accountant or advisor. I think our programs are something that
can bring value to a small business. I will give you a quick little overview
first.
Our first program, the program most people think about, is our loan
program. We have two loan programs, 7(a) an 504 that provides funding to
businesses.1 On the panel before I came up to the podium to speak, , I heard
somebody say it is really hard to get financing because a lot of these startups
lack hard assets.
Well, if you look at our programs, hard assets are not a requirement. Cash
flow is a requirement. We think that Uncle Sam’s guarantee substitutes for
the lack of hard asset – or even the soft asset. We look for cash flow, and if
the cash flow is there and the asset is not, theoretically, you can get funding
under our program to start your business.
There is another program we have to help businesses once they get in
business: government contracting – contracting for small business.2 We
facilitate small business access to government procurement officers in every
department and agency of the United States Government.3
And right now, the segment of government procurement that is devoted
for small business by law or presidential proclamation is $300 billion
annually.4 That’s a lot of money. And we will help you get the right contacts.
The third program we have is technical assistance.5 That’s providing
business plan assistance, marketing assistance, and problem solving
assistance to any business that needs it. It is done gratis.6 It is done through
1
Small Business Administration, http://www.sba.gov/services/financialassistance/
sbaloantopics/cdc504/index.html (last visited Sept. 23, 2007).
2
Small Business Administration, http://www.sba.gov/services/contractingopportunities/
basics/buys/index.html (last visited (Sept. 23, 2007).
3
See id.
4
News Release, Richmond District Office of the U.S. Small Business Administration,
The U.S. Small Business Administration and Mt. Gilead International Ministries to Conduct a
Symposium for Small Business Owners (Sept. 7, 2007), available at
http://www.sba.gov/idc/groups/public/documents/va_do_files/va_october20_symposium.pdf
[hereinafter News Release, Richmond].
5
See Small Business Administration, http://www.sba.gov/services/training/onlinecourses/
index.html (last visited Sept. 23, 2007).
6
Id.
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[Vol. 33 No. 1]
our Small Business Development Centers around the state and also around
the nation. It is also done through the Service Core of Retired Executives –
which again is available to the entrepreneur free, individuals that actually
have business experience in any given area.
And then our fourth area – which lot of VCs that are very familiar with
permitting the SBA to fund Small Business Investment Company. We fund
venture funds that specifically invest in small business.7 Basically they make
the decision on our behalf. They basically make the investment in the small
business, and we take the risk with them.
Sometimes we win, and sometimes we lose on situations like that. But
right now I would like to get back to one of our programs, and that’s our
lending program. Nationwide this year – we are about half way through our
fiscal year (our fiscal year began October 1, so we are just a little over half
way through our fiscal year) – if you analyze the data, the loan data, we will
probably make over 110,000 loans nationwide8 (or guarantee because we
don’t actually make them – the banks make them, and we guarantee them).
So, there are 110,000 nationwide loans this year and there will probably
be about $15 billion.9 That’s a lot of money to fund small business.
Typically, about 20 to 25 percent of those 110,000 loans go to startups.10
These startups can be businesses that have just started in business or have
been in business for two years because our definition right now is that any
business that is two years or less we consider a startup or new business. So in
that 25 percent of startup loans could be someone that has been in business
six months or up to two years. That definition was changed probably about
ten years ago.
Before that, before – let’s say 1997 – we defined startups as true startups,
someone who had never been in business before. And I have a question for
everyone here in the group. Going back, if you look at the true startup,
someone who has never been in business before, not someone who has been
in business six months or two years, what do you think their success rate is?
You people out there that work with startup companies, put money into
startup businesses, new businesses, what do you think their success rate is?
7
Small Business Administration, http://www.sba.gov/smallbusinessplanner/start/
financestartup/SERV_FINANBASICS.html (last visited Sept. 23, 2007).
8
See generally FY 2007, Budget of the United States Government,
http://www.whitehouse.gov/omb/budget/fy2007/sba.html (stating that the Small Business
Administration issued 89,000 loans under the 7(a) program alone) (last visited Sept. 23, 2007).
9
See generally Small Business Administration, http://www.sba.gov/aboutsba/
history/index.html (stating that the SBA backed more than $12.3 billion in loans last year)
(last visited Sept. 24, 2007).
10
See generally Small Business Administration, http://www.sba.gov/services/
financialassistance/sbaloantopics/microloans/index.html (discussing the Micro-Loan Program
which provides small loans to start-ups) (last visited Sept. 24, 2007).
129
MR. ABRAHAMS: One percent.
MR. GOLDBERG: One percent. Okay. Anyone else? I like to throw out
that question to groups such as yours. . I throw it out sometimes at a meeting
with a group of accountants, and I would think the accountants are sharp
once they get out their fine point pencil and know what they are doing. They
usually respond 20 percent, 35 percent, five percent, or two percent.
Well, in the Cleveland District, which is really a small district – we run
from the Pennsylvania line to the Indiana line and cover the northern 28
counties of Ohio11 – back in 1994, we made 364 startup loans.12 We tracked
those startup loans, true starts, for a period of about six and-a-half years. We
found after six and-a-half years that 78 percent were still in business.13 That’s
a remarkable figure. It is even more remarkable when you think it is here in
the rust belt – Northern Ohio. We started to ask questions: why was that so
great?
Now, we basically came down to two reasons. One, we required 286
businesses to do a business plan, to work either with SCORE – The Service
Corp of Retired Executives or the Small Business Development Center – and
develop a business plan or a business model, and we think that was the road
to success, and it really helped them.14
The other thing that contributed to this great success rate was having the
right financial structure, the right amount of equity coming in – whether it is
20 percent or 30 percent – coupled with the right amount of funding.
Contrary to that approach, typically what we see out there is someone who
can’t find access to venture funds or get the proper funding, relies on the
credit card offerings in the mail, they fill out the application, call up the bank
to get the money, and they open up for business without even thinking,
without the business plan, without anyone realizing if they really have
enough money to make the business work.
We think that having the proper financial structure – debt to equity – with
a business plan is the reason why 78 percent of the businesses have
succeeded. The 78% success rate that we had in Northern Ohio can be seen
11
Small Business Administration, http://www.sba.gov/localresources/district/oh/
cleveland/aboutus/index.html (last visited Sept. 23, 2007).
12
See generally id. (discussing the total number of loans made in 2004) (last visited Sept.
24, 2007).
13
See generally Study Shows Start-ups Have High Rate of Success,
http://www.nfib.com/object/3678661.html (citing a national SBA study which found that 67%
of new ventures are successful after 4 years) (last visited Sept. 23, 2007).
14
See
generally
Business
Plan
for
a
Startup
Business,
http://www.score.org/downloads/Business%20Plan%20for%20a%20Startup%20Business_Jul
y.pdf (providing a guide to preparing a business plan by Service CORE) (last visited Sept. 23,
2007).
83
130
[Vol. 33 No. 1]
elsewhere in the Agency. We like to think that companies can say “I got my
start with the SBA.”
Well, some of the companies that got their start with the SBA, some of
them are not household names. Some of them are household names that we
recognize: Outback Steakhouse, Compact Computer, Apple Computer,
Staples, Intel and FedEx.15 There is also one company that I am particularly
fond of. I like ice cream and there is Ben and Jerry’s Ice Cream from
Vermont. They got their start with an SBA loan in the Vermont office, and it
was kind of a rocky start.16
I will let you know a little secret about Ben and Jerry’s. That loan had to
be restructured three times before they made it.17 The banker was running
scared. We told the banker, “You got a guarantee, don’t worry about it. Let’s
see if we can restructure to their cash flow and make it work.”
Three times it was restructured, and it did work, and everyone knows that
it did work, and everyone knows of the success of Ben and Jerry’s.
Look here in Northern Ohio; look at what we do for startups. Last year in
2006, we made 737 startup loans for 34 percent of our total lending.18 So we
do have quite a commitment here. The banks do lend under our guarantee to
startups, even though their first reaction will be, “We don’t lend to
startups.”19 They do, and they have done it. And once you get started, then I
think after you’ve developed about a year track record, you are eligible to
sell to the federal government under any of our contracting programs.20 And
as I said, that’s a $300 billion market.21
In your handout that you have, there is a section on selling to the
government. It looks like this. (Indicating.) It starts out with $300 billion –
you don’t need to go through it as we go through it, but on the second page
15
See CharlotteSteakHouses.com, http://www.charlottesteakhouses.com/news.cfm/Article/
37266/Outback-Steakhouse-SBA-Success-Story.html (stating that the SBA provided $151,000
of working capital which led to Outback Steakhouses success) (last visited Nov. 12, 2007).
16
Jeff Moore, Looking for Start-up Cash?, DETROITER, Feb. 1, 2001, available at
http://www.allbusiness.com/north-america/united-states-michigan-metro-areasdetroit/810131-1.html.
17
See generally Glossary of Terms, http://www.delawarecountybrc.com/
glossaryterms.htm (providing a definition of restructuring a loan) (last visited Sept. 23, 2007).
18
See Mary Vanac, Charter One Gets Top SBA Lending Honor, CLEV. PLAIN DEALER,
December 12, 2006, available at http://www.cleveland.com/weblogs/print.ssf?/mtlogs/
cleve_eedition/archives/print214855.html.
19
See Joseph Anthony, 6 Things to Know About Getting an SBA Loan, MICROSOFT’S
SMALL BUSINESS CENTER, http://www.microsoft.com/smallbusiness/resources/startups/
startup_financing/6_things_to_know_about_getting_an_sba_loan.mspx (last visited Sept. 24,
2007).
20
contractingopportunities/certifications/index.html (providing the requirements for doing
business with the government) (last visited Sept. 23, 2007).
21
News Release, Richmond, supra note 4.
131
of that handout, you will see that there are basically four designations of
types of businesses that the government recognizes, that get special
preference when it comes to selling to the federal government.
One is women-owned businesses.22 There is no special certification you
have to go through. You self-certify that you are a woman-owned business,
that 51 percent of the business is owned by a woman, by a female. By
presidential proclamation, by executive order, five percent of all government
procurement has to go to a woman-owned business, and that translates to $15
billion.23 Again, that’s a lot of money.
Another self-certification program is to service disabled veterans.24 If you
are disabled – if you are a disabled veteran – and again, it is self-certifying,
there is $9 billion, three percent by presidential proclamation or executive
order.25 Three percent is available, and procurement officers at these
government agencies have this goal, and they are judged by the goal, whether
they make it or don’t make it.26
So there is a big incentive for them to help the business get the right
contracts. Then we have two programs in which we do have to certify the
business. One is a Small Disadvantaged Business, and the other is 8(a).27
They have different qualifications. It is done by statute.28 The statute defines
minorities as being disadvantaged under the law (historically) and therefore,
you can qualify for set-aside programs.29 Again, this is five percent of that
$300 billion or $15 billion.30
We also have another program that we certify – called the “HUBZone” –
under utilized business area.31 There is no presumption of historic
discrimination.32 It is just whether you are located in an area that has been
22
Small Business Administration, http://www.sba.gov/services/contractingopportunities/
basics/identify/index.html (last visited Sept. 23, 2007).
23
Id.
24
Id
25
Press Release, The White House, Executive Order: Service Disabled Veterans Executive
Order (Oct. 21, 2004), available at http://www.whitehouse.gov/news/releases/2004/10/
20041021-5.html.
26
contractingopportunities/basics/identify/index.html (discussing the goal of having 5% of
contracting with women-owned small businesses) (last visited (Sept. 23, 2007)
27
Small Business Administration, http://www.sba.gov/aboutsba/sbaprograms/sdb/
index.html (last visited Sept. 23, 2007).
28
13 C.F.R. §§ 124.101-124.112 (2007).
29
See 13 C.F.R. § 124.103 (2007) (discussing the statutory definition of ‘socially
disadvantaged).
30
JAYETTA HECKER, STATUS OF SMALL DISADVANTAGED BUSINESS CERTIFICATIONS 1
(Government
Accountability
Office
2001)
available
at
http://www.gao.gov/new.items/d01273.pdf.
31
GC/BD HUBZone, http://www.sba.gov/hubzone/ (last visited Sept. 23, 2007).
32
See HUBZone – Frequently Asked Questions, https://eweb1.sba.gov/hubzone/internet/
84
132
[Vol. 33 No. 1]
designated a labor surplus or low-moderate income area, and we call that a
HUBZone.33
And if your business is located there, if the business is owned by an
American citizen, and if the business employs 35 percent of its employees
from a HUBZone, it can qualify for certain set-asides and preferences.34
Again, it is three percent of that $300 billion program, a lot of money. The
rest of the packet that you have goes into some detail on those programs. I
won’t go over that at this time.
If you have any questions, I brought the brain trust from the Cleveland
District Office that can answer those. I also brought as part of that brain trust
an individual that can answer questions you might have on our lending
programs. So at this time, I hope you found your Power Point. I can go on
more and more – for a longer time if you haven’t found your Power Point.
MR. STRAATSMA: No. That’s great. Actually, thanks very much, Gil.
Are there any questions at this point?
MR. ABRAHAMS: Just a quick one: Gil, are there any HUBZones in
Cuyahoga County? Which ones, and where are they?
MR. GOLDBERG: There are quite a few HUBZones. How many would
you say, John?
MR. RENNER: HUBZones are designated by census scribes,35 and there
are dozens,36 virtually the entire east side of Cleveland,37 and a lot of areas on
the west side are also HUBZones.38
MR. ABRAHAMS: Within the City of Cleveland proper, Joe, Cleveland
proper mainly?
MR. GOLDBERG: The easiest thing to do, if you have a company and
you want to know whether or not you are in a HUBZone would be to go to
the SBA website – sba.gov – and you click on HUBZone, and there a
program will pop up. You can enter the address of your company and it will
show whether you are in a HUBZone or not. As John said, you know, there
are dozens within the City of Cleveland,39 and let me give you another
general/faqs.cfm#Q3 (last visited Sept. 23, 2007).
33
See id.
34
See id.
35
See generally HUBZone – Frequently Asked Questions, https://eweb1.sba.gov/hubzone/
internet/general/faqs.cfm#Q16 (discussing qualified census tracts and four other qualifying
geographic locations) (last visited Sept. 23, 2007).
36
SBA HUBZone Locator, http://map.sba.gov/hubzone/hzqry.asp?state=oh (click the
black dot representing Cleveland 3 times) (last visited Sept. 23, 2007).
37
Id.
38
Id.
39
Id.
133
example: Ashtabula County, a little further east of Cuyahoga County, the
entire county is designated a HUBZone.40
MR. STRAATSMA: Yes.
DR. BARBER: I just wondered, when you described the success of
companies six and-a-half years down the pike, so to speak, how did you
define success?
I guess my question is: I think often startups evolve, and there may well
be just a small percentage that actually go bankrupt, but they get merged or
acquired. Were they counted in the successes, or did they stay pure?
MR. GOLDBERG: We did not have the resources to track the company
individually. What we looked at was, basically, the cost to the taxpayer since
the taxpayer is supporting the loan via our guarantee program. If they made
their payments in timely fashion and paid off the loan, they were a success.
They didn’t cost the taxpayer any money. So I don’t know how many were
acquired. I don’t know how many grew to a plateau that is sexy enough for
VCs, but we define success as the ability to pay off the loan in a timely
fashion. One other thing if you don’t mind.
MR. STRAATSMA: Please.
MR. GOLDBERG: We mentioned some of our economic development
programs that we have with various entities in our district, and I will just
briefly mention those because this is a way of attracting supplemental equity
to your business – if I could ask Mark and John to hand it out.
We have done an economic development initiative in the City of
Youngstown and one for Wards 1 and 3 here in the City of Cleveland on the
southeast side; Wards 1 and 3 are on the south side. What we have found out
– and I guess as most of you know – the hardest thing for a business to do is
to attract equity.41
So we have come up with free money. But it is not a free lunch for the
small business. If the small business has ten percent of their own equity in
the business or is able to start the business with ten percent equity and can
qualify for an SBA guaranteed loan and can develop a business plan through
the assistance of either SCORE or the Small Business Development
Centers.42 Then the City of Youngstown will supply them with a 15 percent
performance grant that – if they meet certain hurdles – that performance
40
SBA HUBZone Locator, http://map.sba.gov/hubzone/hzqry.asp?CNTY=39007 (last
visited Sept. 23, 2007).
41
financialassistance/equitycapital/equity/index.html (discussing equity capital) (last visited
Sept. 23, 2007).
42
But cf. Small Business Administration, http://www.sba.gov/services/financialassistance/
eligibility/requirements/index.html (indicating that 20% equity is required to be eligible) (last
visited Sept. 23, 2007).
85
134
[Vol. 33 No. 1]
grant or loan is forgiven over a three-year period and actually becomes true
equity.43
The money that Youngstown supplies is subordinated and put on
standby.44 So, no payments are made during the three-year period. So, it
actually is free money, and they don’t have to service the debt.45
If you take their ten percent equity and couple it with the 15 percent
supplemental equity from the city, you have a borrower that has 25 percent
equity and can usually qualify, with a good business plan, for an SBA
guaranteed loan.
Also, Youngstown is providing tax abatements, waiverable city permit
fees, and a facade grant.46 On the east side of Cleveland in Wards 1 and 3, it
is limited to equity funding,47 but again, it is free money that doesn’t have to
be paid back. But it is not a free lunch because you have to meet those pretty
tough requirements.
Thank you.
MR. STRAATSMA: Any others?
Gil, with respect to the profile, your chart here, this identifies by
percentages, and just going over your tenure for the last ten plus years, have
the types of firms changed that you deal with, your client base?
MR. GOLDBERG: When I first came to the SBA in 1994, the majority of
all the loans we did, the biggest bulk, went to manufacturing, both in
numbers and in dollars. That held true until 1996.
In 1996 the largest number of loans went to manufacturers, that is no
longer true. The service sector has become the largest segment in number of
loans. But it was not until 1998 or 1999 that the dollar switched.
Manufacturing took a few more dollars for a few more years, until probably
1997 or 1998.
And it is interesting, going back to the comment that was made on the last
panel, (hard assets): it was very difficult to convert the banks from lending to
manufacturing with hard assets to lending to service with either intellectual
property or leasehold improvements. But I think they understand that lending
now and realize that our guarantee along with the cash flow enables them to
43
THE
YOUNGSTOWN
INITIATIVE
(City
of
Youngstown)
available
at
http://www.ytowndevelopment.com/docs/youngstown_city.PDF (last visited Sept. 23, 2007)
[hereinafter YOUNGSTOWN INITIATIVE].
44
See Youngstown/SBA Initiative, http://www.ytowndevelopment.com/docs/
YOSBAINITIATIVEAPP.pdf (last visited Sept. 23, 2007).
45
See id.
46
YOUNGSTOWN INITIATIVE, supra note 43.
47
A Partnership for Economic Development in Southeast Cleveland, SBA’S REGION V
OFFICE, Winter/Spring 2007, 4, available at http://www.sba.gov/idc/groups/public/documents/
region5/r5_finalsummer2006takefivenews.pdf.
135
lend to a service sector or intellectual property company that does not have
hard assets.
MR. STRAATSMA: Thank you. Thank you very much, Gil.
Our next speaker is John Connell. He represents the Canadian side, and he
is the Director General of Small Business Policy with Industry Canada,
which is a federal government department.
John is a career public servant in Canada. His responsibilities include the
creation of policies and programs, addressing small business development
throughout the country, and between 1998 and 2003, he served as a senior
chief, Industry Analogy Comment for Finance Canada,48 which had a
mandate of increasing industry productivity and competition in a knowledgebased economy.
Between 1995 and 1998, he served as a Privy Council Officer in the
Economic and Regional Development Policies49 of the period, and he now
handles submissions from the Minister of Industry to that body.
John obtained his Bachelor of Arts and Master’s Degrees at Queens
University in Kingston, Ontario, with a concentration on political studies and
public administration. This afternoon he would like to address some of the
methods and some of the issues facing entrepreneurs in Canada and some of
the actions that the federal government will respond to. John?
48
Driving
Canada’s
Business
Success,
http://www.cybf.ca/about-us/board-ofdirectors/bio-johnconnell.htm (last visited Sept. 23, 2007).
49
Id.
86
136
[Vol. 33 No. 1]
CANADIAN SPEAKER
John Connell∗
(presentation unavailable for publication)
DISCUSSION FOLLOWING THE REMARKS OF GILBERT GOLDBERG
AND JOHN CONNELL
MR. STRAATSMA: Thank you very much, John. Any questions for
either of our panelists?
DR. HISRICH: John, my question is for you. You made the point that
going forward, sustaining economic development in Canada would depend
on a high level of immigration. At the same time, it is clear that countries like
China and India are beginning to develop – they will not come to Canada
and, in fact, are here and are going back. Given high demand and the access
to supply, has anybody been thinking how the government is going to deal
with the reality of high demand, no supply?
MR. CARMODY: We have heard a lot about additional financing from
what appears to be government with aided sources, and we heard in the
previous session about the fact that one of the inhibitors to entrepreneurial
development in Canada is the whole role of banks.
I was very impressed with Gil Goldberg’s presentation and looking at the
materials his people passed out, and it is evident there are a lot of financial
institutions in this country who are willing to take a risk, and you are not
necessarily going to be blackballed if you don’t make it once.
How can we perhaps adopt some of those peaks in our own country and
Canada to promote economic growth in the entrepreneurial spirit?
∗
John Connell is a career public servant with the Public Service of Canada. He is
currently Director General, Small Business Policy, Industry Canada. His responsibilities
include the development of policies and programs addressing small business development
throughout Canada. Between 1998 and 2003, John served as Senior Chief, Industry and
Knowledge Economy, Finance Canada. He was responsible for analysis and advice
concerning microeconomic investments and policies aimed at increasing industry productivity
and competitiveness in the knowledge-based economy. Between 1995-1998, John served as
Privy Council Officer in the Economic Regional Development Policy Secretariat of the Privy
Council Office. John handled submissions from the Minister of Industry to Cabinet and
briefings on priorities and issues concerning the Industry Portfolio. Prior to 1995, Mr. Connell
had a long and varied career in transportation policy with Transport Canada, with assignments
in Ottawa, Vancouver and Canberra, Australia. John engaged in studies leading to Bachelor of
Arts (Honours) and Master’s degrees from Queen’s University in 1979 and 1980, respectively,
concentrating in history, political studies and public administration.
137
MR. KANTER: This is a kind of comment as well. Mr. Connell, you
mentioned the importance of exports, especially to the Canadian companies.
I am with the U.S. Department of Commerce Office U.S. Export Sector
System. Bob Abrahams is here from the Toledo office and Henry Adams.
Our focus is on small and medium-sized companies and to encourage exports
around the world, but particularly to Canada because neighbors are the
logical choice for small and medium-sized companies, particularly to work
their counterparts in Canada, to move their products across the border and
northward.
I am sure the consulate at Detroit is working very hard to match the
Canadian clients that you have on the northern side of the border in Canada.
So the role of exports in both directions is probably very important for small
and medium-sized companies, especially in Northern Ohio as well as in
Canada because a lot of the trade is more north and south than east and
west.50
It is easier for an Ohio company to ship to Ontario than it would be to
California.
MR. STRAATSMA: Any further questions or comments? Yes, sir.
DEAN ENTIN: I am just curious about the success rate on small
businesses. I ask this because I know there have been studies in the U.S.
suggesting that the failure rate of small businesses in the first couple of years
is pretty high.
So I was struck, and I have two questions. One is for Mr. Connell: do you
know what the corresponding figures are in Canada? And second, to Mr.
Goldberg: granted, the data you have are based on defaults, but I wonder
with the experience in your office in this area, if it is comparable to other
SBA offices around the country? And if so, does that suggest that the SBA
has figured out a way to pick the best risks for loans? It just seems like a
notably higher success rate than some of the studies that I have seen more
generally.
MR. GOLDBERG: On our statistics, please realize those statistics relate
just to SBA financing, which may be a small percentage, even though I
mentioned we are talking 110,000 loans, and $16 billion annually. That’s a
lot of money but really is a small percentage of those businesses that are
getting loans. Out of that 110,000, probably only 25,000 or so are what we
would classify now as new businesses, two years or less.
But I think that businesses that do come to the SBA perform better, 1)
because of that technical assistance portion, and 2) because of the proper
50
State
Trade
Fact
Sheets
2006:
Ohio,
Government
of
Canada,
http://geo.international.gc.ca/can-am/washington/state_trade_2006/ohio-en.asp (last visited
Sept. 29, 2007).
87
138
[Vol. 33 No. 1]
financial structure. They have the right amount of financing that they need
with the right equity.
You know, too many times I think a business fails because they don’t get
the right amount of funding they need and start behind the eight ball to begin
with, and I think they can make it up as they go along, but they get further
and further and deeper and deeper into trouble.
I mentioned the Youngstown initiative, and again, that’s one where there
is supplemental equity coming in, and there is technical assistance. We made
our first loan in Youngstown in the year 2000.51 And it has been running
constantly since that time, and we have helped approximately 70, 71, 72
companies in Youngstown.52 Some of them are startups, some of them
existing, and out of those 70 or so companies, only three have gone bad. One
was restructured.
But I think that is a good track record, and that’s in Youngstown, Ohio,
probably one of the most severely hit areas in Northern Ohio, and those 70
companies represent about 17 or so million dollars in Youngstown.
One more thing I would like to say. In your packet, that blue and white
folder, there are three handouts. One is the government contract they hand
out. The other one has a 7(a) lending guide on it, and the last one was the
504, another loan program that we have. It has everything you need to know
about the U.S. Government, SBA lending, but were afraid to ask. And if you
do have any questions, I have two experts from the Cleveland District, Mark
Hansel, if he could raise his hand on the finance side, and on the government
contract side, I have John Renner. So if you have questions now or during the
cocktail reception, those are the two gentlemen you could approach.
MR. STRAATSMA: Yes, sir.
DR. BARBER: We have had a lot of input on financing, mainly on
financing, and what I want to say is that I have been involved in studies,
startup of early stage companies where I have talked to the CEOs of
companies that may have been in startup for over five or six years. And the
one question that I want to raise, because it came out of those conversations,
was that their issues were not generally about science or technology or the
ability to understand the applied technology. They were generally not about
money.
Some of them got more money than they needed, which created problems
for them. Some of them got less, which created problems for them. The
really successful ones were all foreigners who didn’t expect any help of any
sort, and they were making it.
51
See generally Cleveland District Office News, U.S. Small Business Administration,
available at http://www.sba.gov/idc/groups/public/documents/oh_cleveland/
oh_cleveland_news07-06.pdf, 2 (last visited Oct. 6, 2007) (describing Youngtown initiative).
52
Id.
139
But the point that came out about it was that the real weakness was about
competence in commerce. None of them had much sense about how to make
the value exchange happen, whether you are in finance or whether you are in
technology. So the question that I want to ask is: what about the human
competence to make enterprises work? Are there any shortcomings here, and
if so, who deals with those?
MR. GOLDBERG: Just one empirical comment. I couldn’t add anything
from a conceptual standpoint to what John had to say. I think we see that in
our loan application process and in our various initiatives. I think it bears out
in reality that those that really have the desire, who really have the skills and
the passion are the ones that actually come forward and make it a success.
And when we first announced the Youngstown initiative, we did it with a
lot of fanfare. The three TV stations were there in Youngstown, as well as
the newspapers. And what people heard from that announcement was free
money. Free money!
The next day, the City of Youngstown got something like 800 calls, the
day after that another 800, the day after that another 800. Maybe a few
people came in, but as you see, it is self-selecting. Suddenly loans were made
out over a couple thousand phone calls and people looking for that free
money. When they realized there was no free money, that they had to have
that desire, passion and ten percent of their own equity, it was self-selecting.
MR. BROWN: My question actually relates to Mr. Barber’s question, and
this is for Mr. Goldberg.
In Cleveland, they have organizations like Team NEOand Nordac. What
kind of role do those organizations play in fostering these issues with
entrepreneurship? Mr. Connell, can you respond with something similar in
Canada?
MR. GOLDBERG: They play a very important role of providing financial
assistance, either in the form of venture fund, grants or subordinated funding
to businesses. I think their’s is an important role for economic development
in the area, and economic development is very fragmented. It takes a lot of
different pieces coming together to make it work. To make it work and know
what business is a success. Team NEO and the others out there are one part.
If we fit our part to someone else’s part, that works, fine, but it is fragmented,
and we are all there to make sure, hopefully, that anyone that has a successful
plan or idea and the right passion to do it so it won’t fall through the cracks.
MR. STRAATSMA: Very good. Gil, John, thank you very much for your
time this afternoon. And we will have time during an hour of discussion.
MR. UJCZO: Just a few logistical announcements. On behalf of the
Institute, we do thank all our speakers for this afternoon. As a native
Youngstowner, we particularly appreciated the last session and as well the
work of the SBA in Youngstown. We are on a half hour break. Cocktail hour
will begin at 5:30 in the room directly above where we had lunch, so it is just
88
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[Vol. 33 No. 1]
upstairs. You go to the light, the sunlight, and that’s where the cocktail hour
will be. Dinner will be started shortly thereafter and the presentation is
upstairs this evening. If you are not joining us for dinner, we will meet
promptly tomorrow morning at 9:00 a.m.
Thank you.
A CASE STUDY OF A SUCCESSFUL PRIVATE
ENTREPRENEURSHIP
Session Chair – Richard Cunningham
Speaker – William A. Davies
INTRODUCTION
Richard Cunningham
MR. CUNNINGHAM: The title that we have on the program is “A Case
Study of Successful Private Entrepreneurship.”
This is one of the successful case studies of private entrepreneurship, but I
am in a difficult position. I have been asked to introduce the senior executive
of a company that destroyed my dream; that totally ruined my great ambition
in life. Let me tell you a story that illustrates my ambition.
My law firm, Steptoe & Johnson – I am Dick Cunningham of Steptoe &
Johnson, for those of you who didn’t know – there was sort of a grand old
man in my law firm, Steve Ales. He was Secretary of Defense in the
Kennedy Administration, head of the Association of American Railroads,
famous litigator in Washington, and all of that.
Ales was, at one point, involved as one of the lead litigators in the battle
for the takeover of Metro-Goldwyn-Mayer. Ales was an enthusiastic, manic
fisherman, and in the second week of June every year, come what may,
nuclear attack, whatever, Ales would go up to Maine to go salmon fishing.
So, in the year when the MGM battle was raging, come the second week
of May, Ales went off to Maine. Sure enough, because the great law of
nature dictates that this would happen, a crisis breaks out in the MGM
takeover case. A younger lawyer – a fellow by the name of Smokey Miller,
who Ales entrusted the case to – had run into Ales’s office and was shocked:
no Ales. Smokey runs across the hall to Ales’s secretary and says, “Got to
call Steve; crisis in the MGM case. Got to get him back.”
She says, “Mr. Miller, it is the second week of June. You know and I
know that Mr. Ales has gone salmon fishing in Maine.”
Says Miller, “Call him back. Get him on the phone. Crisis in the MGM
case. Got to get him back.”
141
89
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[Vol. 33 No. 1]
“Mr. Miller, you know that Mr. Ales goes to a salmon fishing camp in the
north woods of Maine, a hundred miles from the nearest telephone. I can’t
call the boss.”
Miller says, “Call Western Union.”
The site of the story shifts: we are now in the north woods of Maine.
Salmon were everywhere. Early one morning, Ales and others are out casting
a fly for salmon, and out of the underbrush stumbles a Western Union
messenger who I picture in one of these sort of Call-for-Phillip-Morris outfits
with a cap and the gold brocade, except it is all torn to ribbons as he has gone
through the underbrush looking for Ales.
And he says, “Are one of you guys named Steve Ales?”
And Ales says, “I am Ales.”
The kid says, “Telegram for you.” He hands him the telegram. Ales opens
the telegram, and it says, “Imperative you return immediately, or MGM case
is lost.” Signed, “Smokey Miller.” Ales looks at it, reaches into his pocket,
takes out a $20 bill, puts it on top of the telegram, hands it back to the
messenger and says, “You couldn’t find Ales.”
It has always been my ambition to get to the point in my life where I
would have sufficient prestige and grandiose and all that sort of stuff that I
could say in a situation like that, “You couldn’t find Cunningham.”
But I can’t do that any more. As you can imagine from hearing that story,
that ambition is no longer achievable, and it is this man’s company, Research
in Motion, that is to blame. Today everybody is reachable everywhere, all the
time, through their Blackberries.
So, what you are going to hear today is not just a story of a very
successful private entrepreneurship. You are going to hear how a private
entrepreneurship has changed all of our lives. The fellow we have here, Bill
Davies, is going to tell you that story, but he is also going to talk about some
intellectual property issues that I think are really important in our
consideration of the viability – the travails of technology oriented
entrepreneurship.
All of you who read the business section – I am not going to take a show
of hands – but all of you who read the business section know that for weeks
on end during the last year Research in Motion has been in the papers as a
life and death struggle on intellectual property.
Bill Davies is the ideal guy to tell you about all this stuff. He is the
General Manager and President of Research in Motion in their Barbados
operation. This is not his first step in the technology world. He worked at
several positions with Motorola, including as Vice-President and Director of
Technology Transfer. Later he was the leader of their governed relations
team for Latin America.
He is a lawyer. Sorry about that, guys, but this is, after all, the law school
of Case Western Reserve and the Canada United States Law Institute.
Davies—A Case Study of a Successful Private Entrepreneurship
143
His current assignment is to champion Research in Motion’s efforts to
reform intellectual property law. We were just discussing this. He told me
that his major focus is those regulation- addicted Europeans, and what they
do in this sort of thing, although God knows there are enough problems with
that in the United States and Canada, too.
So let me ask Bill Davies to come on and talk to you about Research in
Motion, about entrepreneurship, about intellectual property, and the travails
that one goes through and what ought to be done with intellectual property to
enhance entrepreneurship. And I think you are going to really enjoy this.
SPEAKER
William A. Davies*
MR. DAVIES: Okay. Well, after that sort of stirring introduction, I find it
hard because the first thing that happened to me was Deborah said, “Well,
give him about 15 minutes.” So I got to get all of that in 15 minutes. And
then she said – and this was the one that really hurt – “No Power Points.”
I have been in the high-tech industry for 30-plus years, and I am not
supposed to give a Power Point presentation? Well, okay. So I didn’t do it. I
was very good, and I don’t have any Power Points. However, I did want to
start off with a historical quote. A very intelligent, brilliant leader, Winston
Churchill, once said, “The only statistics that you can believe are the ones
that you fiddle yourself.”
And I want to tell you some statistics that I gathered today. The first one
is that I have met four Case Western students. So, I can tell you that 100
percent of them are beautiful women. Okay?
The second one is that 50 percent of them did not know where the law
school was.
Now, the other two, one is a student here, and the other one was an
alumnae. So there you have the statistics for today.
Well, I have been thinking that I was going to give you a long and rather
boring lecture and talk about E-Bay, and we were going to talk about the
different opinions and how some of them didn’t make sense, and how did
they get so many different ones to all come out unanimous?
But, that would be more boring than you could possibly take on Friday
evening after cocktails. And so we are not going to do that. We will just talk
a little bit about the way the world seems to be working on entrepreneurship.
[Phone rings.] And people call. I have no idea why they called that.
MR. CUNNINGHAM: You are proving the truth of my story. Someone is
looking for Dick Cunningham.
90
144
[Vol. 33 No. 1]
MR. DAVIES: That’s right. Absolutely. Didn’t say that, but it probably
was.
As a matter of fact, this is, by the way, not the absolutely newest version,
but this is the first sort of consumer version of the Blackberry, and it actually
has a camera in it. It actually has an MP3 player in it. I don’t know how to
use the MP3 player, and I can barely take a picture with it. But it does have
those things.
I am very amazed at how they can manage to get all the stuff into these
little tiny packages. I will also tell you one other thing. Now they have
keyboards that are this thin and just a little bit bigger but with a full
QWERTY keyboard. That’s what I want. They haven’t given me one of
those yet.
So let’s talk about entrepreneurship and the law, and we will get some
anecdotes about how RIM is doing. As you know, RIM fell prey to
somebody who could be described as a troll.1 A patent troll is normally a
*
Born in Argentina of an Irish Argentine family, he was raised in Brazil and educated in
the United States. He speaks English, Spanish and Portuguese. He graduated from Purdue
University in Economics and has a Degree of JD, cum laude, from Indiana University School
of Law. During his professional life, William A. Davies has worked for a variety of private
sector enterprises. After service in the United States Army he became a Reinsurance
Representative of Lincoln National Life Insurance Company with responsibility for Latin
America and the Caribbean, it is here that his interest in working with Governments for the
benefit of private enterprise was developed as the Life Reinsurance business is highly
regulated and a significant part of servicing the Life Insurance company clients was lobbying
government on their behalf. He then pursued a legal career; First with Cahill Gordon Reindhel
& Ohl a Wall Street law firm where he had the good fortune to work closely with the former
legal adviser to the US State Department who was then a senior partner at the firm; Second
with Motorola Inc. where he held successively positions of responsibility advising the
business sectors. This included 5 years in Geneva Switzerland where he was very active with
the fledgling European Commission in the lobbying of the necessary rules for the Common
Market while not hindering the conduct of business. He served as Vice President and Assistant
General Counsel and then as VP and Director of Technology Transfer. He also was the
founder and architect of the Motorola Government Relations Team for Latin America, which
he successfully led for 6 years. He then became a Senior Principal for the professional services
firm of DeLevante y Asociados, Panama, R.P. where he consulted for clients throughout the
Americas on spectrum, telecommunications and standards issues. He is currently a General
Manager and President of Research in Motion (Barbados) Ltd. His current assignment is to
champion RIM's efforts to reform of the IPR laws. During his career Davies has served on the
Board of Standards Review of the American National Standards Institute, The Joint
Government Private Committee of Experts on Electronic Commerce of the FTAA, and the
Board of Trustees of Latin American Young Executives, he has been a member of the
Argentine, Venezuelan and Canadian Delegations to the CITEL Permanent Consultative
Committees I and II (formerly III), and has been a frequent speaker at industry Fora.
1
Leslie T. Grab, Recent Development, Equitable Concerns of eBay v. Mercexchange:
Did the Supreme Court Successfully Balance Patent Protection Against Patent Trolls, 8 N.C.
J.L. & Tech. 81, 85-87 (2006).
145
patent-holder who does not develop technology on their own.2 They go out
and buy technology, or acquire it in some way, and then go around and sue
people. Now, that is a fairly, you would think, innocuous sort of thing to do. I
mean, that’s what we do for a living, isn’t it? We sue people.
However, the problem with a patent suit in the United States, at least, is
that until the E-Bay case, injunctions were automatic.3 There was no
consideration. The normal equitable considerations for whether an injunction
should flow or not were left out. So you had a Draconian remedy.
And so it became very easy to be a patent troll because you can easily put
a company like RIM out of business. Before we really go further into that,
though, I want to talk about why it is that these patent trolls exist. This
wasn’t a problem thirty years ago.4
There are two separate reasons why it wasn’t a problem thirty years ago.
One of them is the fact that North America, Europe, and Japan even, have
started to de-industrialize.5 We don’t make things any more. China and the
little tigers, India, have become our factories.
As a matter of fact, I made an interesting observation the other day. I saw
that there is a real issue in Los Angeles about what to do with containers.
Containers come over on ships and are big and 40 feet long and 20 feet wide.
Well, they are heavy, and you don’t send them back.
It is too expensive to send them back, so they end up piling up in Los
Angeles. They have acres and acres of them in Los Angeles. They don’t
know what to do with them because we don’t sell anything to China.6 China
sells to us. So it is kind of interesting.
There are some things that we do sell to China. And obviously, it is very
high-tech things, which are, at the moment at least, still such small markets
that only several firms can have the volume. For example, commercial
aircraft, where you have four firms total that make up the entire market for
2
Id. at 83-84.
Id. at 81.
4
See Jason Rantanen, Slaying the Troll: Litigation as an Effective Strategy Against Patent
Threats, 23 Santa Clara Computer & High Tech. L.J. 159, n.36 (“[P]atent trolling is a fairly
recent phenomenon.”).
5
See Robert Rowthorn & Ramana Ramsawamy, Deindustrialization – Its Causes and
Implications, INTERNATIONAL MONETARY FUND, http://www.imf.org/external/pubs/ft/issues10
(last visited Oct. 13, 2007) (“The trend [of deindustrialization], particularly evident in the
United States and Europe is also apparent in Japan.”).
6
See generally Containers Pile Up as Imports from China Soar, REUTERS, June 15, 2006,
available at http://kerryfoxlive.com/wordpress/?p=568 (“China is shipping so many goods to
the United States that the Chinese often find it cheaper to guild new containers . . . and leave
the empty ones in the United States.”), see also Bruce Odessey, While U.S. Exports to China
Rise,
Imports
From
China
Rise
Faster,
USINFO,
http://usinfo.state.gov/eap/Archive/2005/Mar/03-517799.html (last visited Oct. 13, 2007)
(shows trade volume for U.S. trade with China).
3
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[Vol. 33 No. 1]
commercial aircraft – two that dominate it: Boeing and Airbus – and a couple
of others like Embraer and Bombardier.7
As a matter of fact, I flew in a Bombardier jet up here from Dallas on the
way here. It was a very nice plane, very nice plane. I liked it a lot. So, we still
sell those kinds of things, but that’s because that market is not big enough to
have 50 competitors that are efficient. It is now consolidated, but it used to
have 50 competitors.8 And then, we also have some very high-tech things,
which are still so closely tied to their markets that it is hard to replace them
with just raw manufacturing capacity, like Blackberries. Believe it or not,
every Blackberry here – and there are a lot of them I noticed – was made in
Waterloo, Canada.9
It is amazing when you go there. I can’t remember the last time I saw a
real factory in North America, especially a high-tech factory. We still have
the big heavy factories, but high-tech is kind of a rarity now.
And the other thing that has happened and it is something that may be part
of the problem, is that more and more things are networked. This has
obviously come about because of the Internet (which has expanded
enormously) and also because the physical networks that carry the Internet
have expanded enormously as well.10
Now, for example, the cellular industry is putting out things that have two
or three megabytes throughput.11 The other wireless things like Wi-Max are
going to have even more. So we have an expansion of those networks, both
the physical networks and the logical network, and we, therefore, get more
and more equipment that makes our lives easy, that are networked.
In other words, now we have refrigerators that are networked.12 And it is
quite common now to have security systems that you can access anywhere in
7
Id. (China imports commercial aircraft from the U.S.).
See generally Michael J. Harrison, U.S. versus EU Competition Policy: The BoeingMcDonnell Douglas Merger, AMERICAN CONSORTIUM ON EUROPEAN UNION STUDIES: CASES
ON TRANSATLANTIC RELATIONS, NO. 2, 4 http://www.american.edu/aces/Cases/ACES
Competition Policy.doc (last visited Oct. 13, 2007) (refers to consolidation of commercial
aircraft industry).
9
See generally Company, RIM, http://www.rim.net/company/index.shtml (last visited
Oct. 13, 2007) (RIM is based in Waterloo, Ontario.).
10
See generally Aggelos Bletsas, Physical Limitation on the Expansion of Internet, MIT
MEDIA LAB http://web.media.mit.edu/~aggelos/861.html (last visited Oct. 13, 2007) (describes
how the expansion of the Internet depends on the expansion of physical networks).
11
See, e.g., Pascal Deriot, XIM vs. Code Shadowing Architecture, MICRON TECHNOLOGY
http://www.wirelessdesignmag.com/ShowPR.aspx?PUBCODE=055&ACCT=0030150&ISSU
E=0312&ORIGRELTYPE=FE&RELTYPE=PR&PRODCODE=00000&PRODLETT=B&Co
mmonCount=0 (last visited Oct. 13, 2007) (discusses throughput capabilities of late model cell
phones).
12
See, e.g., Samsung’s Revolutionary Digital Network Refrigerator Keeps the Kitchen
WIRE,
Apr.
4,
2002,
available
at
Connected,
BUSINESS
http://findarticles.com/p/articles/mi_m0EIN/is_2002_April_4/ai_84392672
(discusses
8
147
the world.13 You know, I have a beach house in Panama that has a camera in
it. In my house in Barbados, I can look and see what’s going on at my house
because there is a little camera I can move and which I can look at through
the Internet.
And that’s just an example, but it happens with an awful lot of things, and
it is getting cheaper. So, for example, as I understand, you can get coffee
makers that are networked.14 If you unload coffee in them a week ago, it will
grind them tomorrow and brew it the day after, whatever. I don’t know that
you would want to do that with a coffee maker, but apparently, you can.
But what this brings about – and it is something that sometimes those of
us who are not engineers forget – is that you have to have all these things
play together. So we have to have networks. Networks require standards for
their interfaces.15 In other words, that refrigerator or that camera in Panama
has got to somehow talk to my computer in Barbados or, for that matter, my
hotel room over here. It has got to talk there, but it has to play with a set of
standards.
And the standards have become very important because of the
networking. When I first started in the high-tech business, they didn’t do
standards. What did they do? They did E-1s.16 Who cares about E-1s, right?
They did a few other things. The network standard they had was AT&T’s
Notes on the Network.17 That was it, and nobody needed anything else.
Now, there is no AT&T, and Notes on a Network is someplace in the
archives of some library; a mere famous historical document. But now, what
we have instead is an enormous number of standards. All these standards are
built by different organizations, some of which you may have heard of and
some of which you wish you never have, like ISO, ITU, ANSI, all the ones
example of a networked refrigerator).
13
See generally George Jones, Build a PC-based Home Security System, BYTE.COM
http://www.byte.com/documents/s=9988/byt1151252609290 (last visited Oct. 13, 2007)
(explains how to build a networked security system).
14
See Russel Redman, ‘Connected Kitchen’ Product Line Debuts at CES, CRN,
http://www.crn.com/digital-home/18825238 (last visited Oct. 13, 2007) (describes networked
kitchen appliances, including coffee maker).
15
See generally Jim Duffy and Tim Green, Dearth of Standard Stalls Ethernet Services,
NETWORK WORLD, June 13, 2005, 79 (lack of standard Ethernet interface impedes plans to
extend networks).
16
See generally E1 Tutorial: An Overview of the Basics of the E1 Digital Transmission
Telecommunications Link Standard Used Predominantly in Europe, RADIO ELECTRONICS.COM,
http://www.radioelectronics.com/info/telecommunications_networks/telecommunications_standards/e1/e1.php
(last visited Oct. 13, 2007) (overview of E1).
17
See generally AT&T Dumps Network Notes, CNET, http://www.news.com/ATT-dumpsNetwork-Notes/2100-1023_3-206380.html (last visited Oct. 13, 2007) (discusses AT&T
Notes).
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[Vol. 33 No. 1]
that report to ANSI, ATIS,18 et cetera, et cetera. All of these are acronyms,
which you certainly don’t need to remember.
But they are, in essence, organizations of private businesses that put
together standards so that their equipment or their software can interoperate
with the other equipment and software in a network.19 This is an enormous
effort. It goes on all the time, but one of the things that happens – and this is
important also – is that every private company (as well as academia) is trying
to make sure their patent is in the standard. Okay? So we have a couple of
things.
First, the deindustrialization of the West – I hate to use that. It sounds so
incredibly apocalyptic – none of us in the West have lost an inventive edge.
We are still inventing away and producing intellectual property. Part of what
we are doing is buying the stuff from the Chinese with our intellectual
property. You know, to give you a good example of why our intellectual
property is still very important is to look at the movie industry. Most of the
movie industry is owned by the Japanese.20 Not all of it. Part of it is owned
by the Australians.
But the intellectual property that resides in Hollywood is such that that’s
where you make movies. That’s where you find directors. That’s where you
find make-up people. That’s where you find all of these people that make up
the intellectual property that goes into a movie. That’s very valuable.
And so what happens is that we are buying, oh, I don’t know, this
microphone from the Chinese by selling them movies, which is basically
intellectual property. It is one of the reasons why people who are in that part
of intellectual property are so interested in copyrights and piracy. That really
is one of the major issues of our balance of trade21 – the West’s balance of
trade, not just the United States.
I was once told that a company which you have probably never heard of,
called Televisa, is the second largest foreign exchange earner in Mexico.22
18
See
generally
Internet
Related
Standards
Organizations, FAQS.ORG,
http://www.faqs.org/rfcs/inet-standards.html (last visited Oct. 13, 2007) (includes hyperlinks
to Internet standards organization Web sites).
19
See,
e.g.,
About
Us:
OpenOffice.org,
OPENOFFICE.ORG,
http://about.openoffice.org/index.html#history (last visited Oct. 13, 2007) (example of a
standards organization heavily backed by the private company Sun Microsystems).
20
See, e.g., Affiliated Companies (Outside Japan), SONY CORPORATION,
http://www.sony.net/SonyInfo/CorporateInfo/Subsidiaries/outside.html (last visited Oct. 13,
2007) (Sony Global Corporation, with headquarters in Tokyo, lists Sony Pictures – major
producer of movies – as one of its affiliated companies).
21
See generally Moeen Qureshi, Henry and Hank, THE WALL STREET JOURNAL, Apr. 21,
2006, at A14 (“No doubt [China and the U.S.] have serious issues to resolve on monetary
policy, balance of trade and protection of intellectual property.”).
22
See generally Televisa, http://www.televisa.com/index_eng.html (last visited Oct. 13,
2007) (refers to Televisa as the world’s largest Spanish Language media corporation), see also
149
They put out these horrible but Copyrighted Telenovelas – which no one in
their right mind would watch – which are the most popular thing on
television all over the Spanish-speaking world, including the United States,
by the way.23
But they are the second largest foreign exchanger in Mexico because of
Telenovelas. So this is valuable stuff. It is very important to us, especially
with, as I said, the deindustrialization of the West.
So what has happened is that an awful lot of the industrial giants of the
West have become IPR houses. We patent, we copyright and we enforce
patents. So you have to have standards in your product regardless of what
product you make.
In other words, for example, let’s take the Blackberry. We have a lot of
nonstandard stuff in here and a lot of proprietary stuff, which makes it a
Blackberry: your push e-mail, touch and feel, the ease of work and all that,
that’s all proprietary.
By the way, I will break off and tell you a story. My daughter – my oldest
daughter – I gave her a Blackberry. About two weeks ago I got a message
from her, which said, “I am finally using the Blackberry for what it is really
meant for. I am sending this to you from under the table in a boring
meeting.”
And it is a niche, and it is a nice niche. Now, any –
MR. CUNNINGHAM: We rehearsed this in advance by the way.
MR. DAVIES: But anyway, the fact is that all of these things that we
have on here all ride on top of standard stuff. In other words, the radio, in the
case of this GSM, GPRS and EDGE – none of which you need to understand,
they are standards for making cellular networks work – are in the radio, and
without them, it wouldn’t work.24
So it is not like a stand alone PDA any more. I don’t know if you
remember Palm Pilots. They didn’t need anything that was standard because
they were not networked together. Now they do, by the way, because they
GRUPO TELEVISA, S.A., REPORT OF FOREIGN ISSUER (FORM 6-K) (2006), available at
http://sec.gov/Archives/edgar/data/912892/000089534506000596/am6k4_grupo.txt (Televisa
is the largest Spanish speaking media company in the world and equity owner the largest
Spanish language media company in the U.S.).
23
See generally Telenovela, THE MUSEUM OF BROADCAST COMMUNICATIONS,
http://www.museum.tv/archives/etv/T/htmlT/telenovela/telenovela.htm (last visited Oct. 13,
2007) (describes Telenovela genre), see also Ronald Grover, Televisa and Univision: Stay
June
27,
2006,
available
at
Tuned!,
BUSINESSWEEK,
http://www.businessweek.com/investor/content/jun2006/pi20060627_999458.htm?campaign_
id=tbw (36% of Univision programming consists of telenovelas licensed from Televisa.)
24
See
Enhanced
Data
Rates
for
GSM
Evolution,
TELECOMSPACE,
http://www.telecomspace.com/datatech-edge.html (discussing the EDGE enhancement to
GPRS networks) (last visited Oct. 6, 2007).
93
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[Vol. 33 No. 1]
have now started to have cellular and two-way paging in them. Now they
have to have standard things, and that’s because of the networking.
So what is really happening, because of these two trends, is that
intellectual property has become very important to any entrepreneur, hightech, obviously, but even not-so-high-tech. I think the movie industry and the
television industry, even with things like Telenovelas, tells you that
intellectual property is important.
And what has happened, therefore, is that people have become much
more aware of it. There is a lot more patent activity going on. Everybody
does their thing with copyrights. They are all worried about piracy, as they
should be. What has happened with that is that, for every entrepreneur, we
now have to run a gauntlet of the patents that are in the air, because that’s
what people do now. Instead of making things, they invent things and patent
them and also the patents therein embedded in standards.
The patent troll is really a creature of these two environments, or these
two changes. It is interesting, the Europeans, by the way, are trying to change
their patent system radically. But one of the things they want to do is to have
a new treaty. I don’t know if you know what the European patent system is
right now.
There is a patent system in almost all the countries, and there is also the
European Patent Office.25 The European Patent Office when it grants a patent
– it is in Munich – when it grants a patent, you don’t get anything except the
right to take that patent and turn it into a national patent.26 So, in essence, you
get the right to have thirty-three national patents issued from a European
patent. However, you have to enforce them in each country.
So, Europeans thought up a new idea, which they called the European
Patent Litigation Agreement (EPLA), which was designed; it appears, in
order to make life easy for the troll.27 It will only use three languages.28 Now,
there is a reason for that. It is better to have three languages than thirty-three
languages. But, what it does is it makes it very difficult for some poor
schnook in Andalucia who has never heard English, French, or German to be
able to defend himself. And, as all of you who are attorneys know, you have
to have your client actively participate in and understand the litigation.
Otherwise, it just doesn’t work very well. Additionally, judges will all come
from the European Patent Office, and their loyalty will be to the European
25
The European Patent Office Homepage, http://www.epo.org/ (last visited Oct. 7, 2007).
See How to Apply for a European Patent, http://www.epo.org/patents/One-StopPage.html (stating that a European patent is a “bundle” of national patents) (last visited Oct. 7,
2007).
27
See
generally
EPLA
–
European
Patent
Litigation
Agreement,
http://www.epo.org/patents/law/legislative-initiatives/epla.html (discussing the history and
some details of the EPLA) (last visited Oct. 7, 2007).
28
Id.
26
151
Patent Office, the people who have issued the patents.29 So finding one of
them not valid is going to be a rare occasion under the European Patent
Litigation Agreement.
A part of my job now is, as a matter of fact, to lobby against the EPLA.
And fortunately for me, the French don’t like it either.30 As I made a
comment to my boss when the French came out with their statement that they
wanted something different than EPLA, he said, “I can still see Admiral
d'Estang’s fleet out on the horizon there. They came to our rescue again.”
However, he then reminded me that it was a Canadian company.
But the fact is that the EPLA is a bad approach.31 And we hope that the
community, rather than the EPO, will be the people in charge of the EPLA –
or something like the EPLA – because you have more checks and balances at
the European Court of Justice. And, you have the national judiciaries that can
be tapped and those kinds of things.32
Oh, I only have five minutes? You could have just said five minutes. You
were trying to be subtle, weren’t you? Okay. Shall I go faster? I can just quit
now. Okay. See, I switched to the last page of my notes. I hadn’t even turned
from the first page before that. All right?
That’s the European problem, and I can talk for a couple of hours on that
one, but I won’t. In fact, I will really quit.
So what we are really talking about now is that every entrepreneur,
especially new ones, has to do two things. One, they have to have an R & D
department, an innovation department. And then they have to have a legal
department. And everything else is superfluous. If you don’t have those two,
you are out of business.
And I think that that’s something – well, it is good for the profession, it is
delightful – it actually is not very efficient for the economies. And so we
have to fix the problem of the IPR law. And I don’t know how yet, but I am
trying to figure it out. If anybody has any ideas, I will be happy to hear them.
See, I am all done. Okay?
DISCUSSION FOLLOWING THE REMARKS OF WILLIAM A. DAVIES
MR. CUNNINGHAM: Okay. Great. You can’t leave. We have questions
and answers. You can’t get out of here that quick.
MR. DAVIES: Okay.
29
Paul Meller, European Parliament Wants Changes to Patent Agreement, IDG NEWS
SERVICE, Oct. 12, 2006, http://open.itworld.com/5007/061012eupatent/page_1.html.
30
France: Why We Oppose the EPLA, MANAGING INTELLECTUAL PROPERTY, Jan. 9, 2007,
http://new.managingip.com/Article.aspx?ArticleID=1257409.
31
See EPLA: Full Briefing, http://epla.ffii.org/briefing (listing a number of criticisms of
the EPLA) (last visited Oct. 7, 2007).
32
Id.
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MR. CUNNINGHAM: I have to say in MC-ing the questions and
answers, you have to understand how low-tech I am.
One of my associates put a “Dagwood and Blonde” cartoon on my door in
my office, and it shows Dagwood going in to return a cell phone that he has
bought. He is complaining that it is too complicated, and he can’t understand
it. And that all he wants is a phone that sends and receives telephone calls.
The young salesman just goes ballistic and says, “I don’t have time to deal
with a lunatic like you.”
Let me begin with a question. We have talked about how the EU patent
system and its conduciveness to trolls and things like that is not good – is
counter productive for an entrepreneurial system. Is there anything you could
single out about either the U.S. or the Canadian system that jumps to mind as
something that really needs reform in terms of patent protection for
entrepreneurs?
MR. DAVIES: First, let me correct that statement a little. The European
system as is, is pretty good.
MR. CUNNINGHAM: As proposed, it is pretty bad.
MR. DAVIES: As proposed, it is awful.33
MR. CUNNINGHAM: Okay. That’s what is called progress.
MR. DAVIES: Yes, that’s right. What would I change in the U.S. system?
I guess the Supreme Court did a pretty good job on E-Bay. But I guess I
would make sure that there was always adequate time for review of a patent
on validity, and I would put back some sort of connection between courts and
the Patent Office. Right now, as you know, the Patent Office and the courts
don’t necessarily pay attention to each other.34
And we need to put that connection back together, because if the Patent
Office is at all good – we won’t go into that, that’s too much of a problem,
whether they are good or not – but if they are doing their job, they can serve
as a pretty good technical resource for the courts. But right now we have it
pretty well disconnected. There is no way the Patent Office can serve as that
resource.
DR. KING: What would you do, make them advisors? Is that it?
MR. DAVIES: Well, you know, the German system is pretty good. What
the Germans do is – they don’t have a connection with their Patent Office,
either – but what they have is, they have three judges. There are two legal
judges and one technical judge for every patent case.35 And the technical
judge is drawn from that technology.36
33
See Id.
See generally Justia: Patent Overview, http://www.justia.com/intellectualproperty/patents/ (discussing the roles of the United States Patent and Trademark Office and
the federal courts in the patent system) (last visited Oct. 7, 2007).
35
But see The Technical Judge in the German Patent Proceeding,
34
153
In other words, if it was an electronics case, it would be an electronics
technical judge. It works pretty well. There are very little problems with
judges who don’t know what they are talking about on technology. I don’t
know if that would work here because we are so invested in our system –
which by the way I think is a great system (the jury system) – that I doubt we
could get away with changing to a technical judge.
But I think it is something that would give technical weight and advice to
the courts and would be very, very useful.
MR. CUNNINGHAM: Interestingly, in the United States, in one part of
our patent protection system, that is, Section 337, which is a device for
protecting against imports that are violating patents and copyrights,37 you do
have a technical judge.
MR. DAVIES: Right.
MR. CUNNINGHAM: And I have known people who have said, “Boy
that makes it much better.” Then, usually among people who have lost the
cases, they say, “Boy, what you really need is a jury of good men and
women.”
MR. DAVIES: That’s an administrative remedy.
MR. CUNNINGHAM: That is an administrative remedy. Right.
MR. DAVIES: So you can get away with that, but not in the law, not in
the courts.
MR. CUNNINGHAM: Right. You are drawing a distinction that some of
my partners draw between what I do and practicing law. But can we have
some questions from the audience here? Yes, sir.
MR. HICKS: You have talked about the importance of research and
development and legal groups in your company working together. We kind
of know a little about how the two groups interact. Could you comment on
how the two groups interact, with what frequency? Is it a month later, a
quarterly review of what is or is not patentable?
MR. DAVIES: Well, on the patent side, we have a patent committee, as
every R & D based company does, and the patent committee meets every
couple of weeks, actually. One of the things it does is to review for
http://www.bpatg.de/bpatg/das_gericht/techn_richter_englisch.html (stating that Technical
Boards of Appeal are composed of three technically qualified judges and one legally qualified
judge and that Revocation Boards are composed of two legally qualified judges and three
technically qualified judges) (last visited Oct. 7, 2007).
36
Cf. id. (stating that technically qualified judges do not need to be experts in the specific
field of expertise at issue in a case).
37
Understanding Investigations Of Intellectual Property Infringement And Other Unfair
Practices In Import Trade, http://www.usitc.gov/ext_relations/about_itc/us337.htm (last visited
Oct. 7, 2007).
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[Vol. 33 No. 1]
patentability, innovation, prior art, and those kinds of things – the usual
things that a patent committee does.38
And the patent committee has a representative from the patent litigation
people. So there is somebody who is part of the legal team that is on the
patent committee. That’s different from the normal patent committee, which
is made up wholly of engineers.39 Also, the engineers that are in it, almost all
of them are ones who exhibited interest in doing that, who weren’t
shanghaied if they are interested.
For example, one of our people on the committee is probably one of our
brightest young engineers, very creative, and he has also got the sort of mind
that remembers everything. And so he is just wonderful because somebody
comes up with a thing that everybody says, “Wow, how did you think of
that?” And he says, “I think in 1947…” You know? And the engineer who
thought it up had never heard of this 1947 thing and finds the prior art that
way.
MR. CUNNINGHAM: I find all this to be refreshingly antiShakespearean. As you recall, he said, first thing we do, let’s kill all the
lawyers. And now the first thing we do is keep the lawyers, and one other
group.
Doug, you had a question.
DR. BARBER: I was wondering if there hasn’t been some significant
change, which isn’t just about globalization, shifting, manufacturing, and so
on. I have been around long enough to remember when getting a patent
approved was a pretty rigorous process, and it was a very rigorous process on
prior art, and that kind of thing, and once you got it approved, you had this
feeling that you had an airtight case with the patent itself.
Today, the impression I get is that you can patent anything because
otherwise how do the trolls take patents? And it is kind of left up to the
courts to decide whether it is valid or not. And then the issue of prior art is
often just one of the elements in the argument. It may not be a significant
one.
Is that a change that has taken place, and how did it happen?
MR. DAVIES: Well, I don’t know exactly, but I think it has happened,
and it has gotten a lot easier to come up with some pretty silly ideas.40 The
idea that you could patent business methods…41
38
See generally Practical Tips for Managing a Biotechnology Patent Portfolio, June 3,
1998, http://www.townsend.com/resource/publication.asp?o=4358 (recommending the
formation of a corporate patent committee and describing the responsibilities of such a
committee).
39
But see id. (suggesting that one of the members of a patent committee should be a patent
attorney).
40
See generally Teresa Riordan, Patents; An Appeals Court Says a Mathematical Formula
Can be Patented, if it is a Moneymaker, NEW YORK TIMES, Aug. 3, 1998 at D2, available at
155
MR. CUNNINGHAM: [Phone rings.] This is all designed to show that
this audience is more important.
MR. JANSEN: Is that message saying he has got five minutes?
MR. CUNNINGHAM: I will handle that message.
MR. DAVIES: That was low-tech.
MR. CUNNINGHAM: This was the five-minute message.
MR. JANSEN: He wanted to know what the bank was offering.
MR. DAVIES: Yes. To answer the question, I think it has gotten easier.
We changed the criteria when we allowed for computer-implemented
inventions.42 What happened was that they forgot about the fact that it has to
be an invention, and there were an awful lot of computer-implemented
things, which have nothing to do with the physical world.43
So, I think, that’s one of the things that has happened. And also, the pace
of patenting has gotten to the point where, for a while the Patent Office was
overwhelmed, and they couldn’t do anything. Now they just came out with
something, by the way, which I am horrified about to a certain extent. It is a
new streamlined procedure.44 You are supposed to do certain things to get the
streamlined procedures, but I can just see what’s going to come out of that
one.
MR. CUNNINGHAM: One of the things, one of the problems we dealt
with when we were working with your old company, Motorola, was the
Armageddon. Everyone was supposed to get buried by Japan, and then
everyone was going to get buried by China.45 That was a concept called
patent flooding where the idea was that Japanese companies would see a
valuable patent held by Motorola, or in your case by Research in Motion,
although you didn’t exist at that time, and they would do literally hundreds of
patents all around that with tiny variations on your patent, such that
whenever you went to Japan, you would encounter things that were almost
http://query.nytimes.com/gst/fullpage.html?res=9D0CE6DE1F38F930A3575BC0A96E95826
0 (quoting Richard H. Stern saying that “The direction the Federal Circuit has been moving is
to say you can patent anything as long as it’s economically valuable.”).
41
Patent Business Methods, http://www.uspto.gov/web/menu/pbmethod/ (last visited Oct.
7, 2007).
42
See Diamond v. Diehr, 450 U.S. 175 (1981) (holding that using an algorithm on a
computer could be patentable).
43
See generally Michael Guntersdorfer, Software Patent Law: United States and Europe
Compared, 2003 DUKE L. & TECH. REV. 6 (2003) (stating that the U.S. unlike Europe does not
require inventions to exist in the physical world to be patentable).
44
See generally Patent Docs: An Analysis of the New Rules: 37 C.F.R. §§ 1.78(d)(1) and
1.14: Streamlined Examination, http://www.patentdocs.us/patent_docs/2007/09/an-analysis-o5.html (discussing the new streamlined procedure for continuation applications) (last visited
Oct. 7, 2007).
45
See Sri Krishna Sankaran, Patent Flooding in the United States and Japan, 40 IDEA
393 (2000) (discussing patent flooding in Japan).
96
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[Vol. 33 No. 1]
entirely identical to yours, but they were patented. Indeed, sometimes they
brought cases against you for infringing their patent.46
MR. DAVIES: Their patent.
MR. CUNNINGHAM: Is that still an issue?
MR. DAVIES: Not really.
MR. CUNNINGHAM: Why has that ceased to be an issue?
MR. DAVIES: Well, first of all, I think, because Japan has gotten freer in
their imports.47 And I think that was basically a non-tariff barrier that they
were working. And MITI has stopped pushing – I’m sorry. Maybe it is –
MR. CUNNINGHAM: No. That’s what we tried to get MITI to do. I
mean, my God, we won, and we didn’t know it.
MR. DAVIES: Well, I don’t think we won. I think it is just the world
changed.
MR. CUNNINGHAM: That’s what I always say when we win.
Henry?
DR. KING: Yeah. Is there much of a case for a North American patent
system?
MR. DAVIES: Well, I suppose there could be. The issue, again, would be
right now where we have – we only have one patent system in North
America that anybody pays attention to, and that’s the U.S. system. I know
that both the Canadian and Mexican patent offices exist. People file there,
but they don’t file initially there. They file in the U.S. first.48
So it is really sort of an integrated one. I think it would be great if
NAFTA had run a system. They were to get our reforms in through there.
MR. CUNNINGHAM: Other questions?
Well, I think this has been terrific. Certainly, I learned a lot, a terrific
presentation.
And I got to say that your company stands out as the sort of thing that the
West needs to look to as the model for how we are all going to preserve our
economic role in the world rather than what the doomsayers say is going to
happen to us.
If we can all give a hand to Bill here.
MR. UJCZO: And we are completed for today. The bar area will remain
open for about another hour or so here, so we invite you to continue the
46
Id.
See generally Michael Richardson, Asia-Pacific Sees a Chance for Freer Trade,
INTERNATIONAL HERALD TRIBUNE, January 19, 2001 at 17, available at
http://www.iht.com/articles/2001/01/19/trade.2.t_4.php (discussing bilateral trade negotiation
involving Japan).
48
See Patents, http://www.graytown.ca/dbus/legal/patents.htm (recommending that
Canadian inventors in the United States file in the U.S. first or obtain a foreign filing license
because otherwise a patent granted by the U.S. may be held invalid) (last visited Oct. 7, 2007).
47
157
professional and personal relationships and conversations that have been
established throughout dinner.
For those members of the Canada-United States Law Institute Executive
Committee, we will be meeting about 8:30 in the Dean’s Conference Room,
which is straight away down the hall, and just take a hard right when you get
to the glass. Don’t walk into the glass, please.
For those of you that are retiring for the evening, we will see you at 8:45
in the morning as we open with our first session. It will be a tough day to
match, but I think that all of our panelists tomorrow are up to the challenge
as well. So we thank you again. We thank all of our speakers today for their
comments as well as for – to all of you for being here throughout the day
today, and we look forward to seeing you in the morning. Take care.
97
PEOPLE ASPECTS OF ENTREPRENEURS: PERSONAL SERVICE
CONTACTS WITH KEY PERSONNEL INCLUDING NONCOMPETE CLAUSES, METHODS OF REIMBURSEMENT FOR
COMPANY SUCCESS, INCENTIVES (PROFIT-SHARING OR
OTHER), AND EFFECT OF IMMIGRATION RESTRICTIONS ON
ENTRANCE OF POSSIBLE ENTREPRENEURS INTO CANADA
AND THE U.S.
Session Chair – Gerald “Jerry” Torma
Canadian Speaker – John D.R. Craig
United States Speaker – Benjamin W. Jeffers
INTRODUCTION
Gerald “Jerry” Torma
MR. TORMA: Good morning. Can everyone hear me all right? Can
everyone hear me okay? Good morning to everyone.
My name is Jerry Torma from the Nordson Corporation, and I am very
pleased to be here today. I would like to thank Henry King and the other
advisors and other organizers for their kind invitation to be here to represent
Nordson Corporation at this extremely valuable and worthwhile event.
I will introduce our two presenters in just a moment. Nordson Corporation
was founded in 1954 by Walter G. Nord and his two sons, Evan Nord and
Eric Nord.1 All three of them received their engineering degrees here at the
Case Institute of Technology. The first product was airless electrostatic
painting established and founded by and developed and discovered by a
person from Case.2
As early as 1965, when Nordson was a relatively small company, they
began their operations in Canada, and it was still very entrepreneurial in
nature. And ever since 1965, Canada has been a truly important source of
road for Nordson in three ways:
1
Nordson History, http://www.nordson.com/Corporate/History/ (last visited Nov. 10,
2007).
2
Id.
159
98
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[Vol. 33 No. 1]
Number one: it provides sales, number two: it is a source of executive and
managerial talent, and, three: it has always been managerial rather than
entrepreneurial. It has always been rather unique in its innovative and
technological contributions.
All of you have there in front of you a brochure called Northeast Ohio,
and if I could ask you to open up to the center and look on the right-hand
side. It reminds us that Northeast Ohio is a link to international business. The
graph or chart or map on the right-hand side, in the middle there, also is very
illustrative in that it shows us that Ohio and Canada are inextricably tied
together.
There is a mutual interdependency in business, and many of us consider
the Southern Canadian, Northern Ohio region, Northern United States and
Midwest region as one economic unit, not two. So I think it is very fitting
that we have this conference and presentation today to reinforce the oneness
of that economic unit.
We are very fortunate to have with us this morning two presenters who
are extremely experienced and extremely knowledgeable. I am sure we will
all benefit from them. One of the principals I like to see sometimes is what I
call three-way communication. Hopefully, one way is, from the three of us to
all of you. Equally important I think is from all of you to us – your questions
– and then sharing three-way communication participant to participant. So
with no further delay, I would like to ask Benjamin Jeffers to introduce
himself and to give the appropriate background and presentation followed by
John Craig, our visitor and guest, pleased to have him from Canada.
Ben?
Benjamin W. Jeffers∗
MR. JEFFERS: Good morning. I am very happy to be here. I want to
thank the Institute for letting me come and speak this morning.
*
Mr. Jeffers has experience in complex business disputes for both plaintiffs and
defendants, at trial and appellate levels of state and federal courts, as well as other forms of
alternative dispute resolution. His practice focuses on commercial matters and class actions,
with a particular emphasis on automotive OEM/supplier disputes, antitrust and other unfair
trade practice claims, and franchise and distributorship cases. Mr. Jeffers also has significant
expertise with insurance company guaranty fund laws. He has successfully represented clients
in many areas of litigation. Mr. Jeffers received both B.A. and J.D. degrees from the
University of Michigan.
Craig & Jeffers—People Aspects of Entrepreneurs
161
I have a litigation background, and my specialization is in commercial
litigation. I have experience in a lot of supply issues, particularly when they
rise to a dispute level. I also spend a fair amount of time working with small
businesses, dealing with issues of non-competes, employment situations, and
company secrets. Hopefully – and part of what I enjoy – is counseling and
providing guidance that helps them avoid litigation. Certainly, my
specialization is getting involved when there is a dispute. I come from
Detroit, and I am one of the few that can say when I look across the border to
our colleagues, I am actually looking south. That is a little known fact that
has tripped up a politician or two here and there, and it is a fun place to be.
The people aspect of entrepreneurs is potentially a very broad topic, and
what I decided I would like to do this morning is just address a couple of
distinct issues. All of these things are things that I think entrepreneurs or
business venturers need to think about when they are dealing with personnel
decisions.
Of the three things that I want to speak about, first, is very briefly some
current events and immigration issues. Candidly, this is not my area of
specialization, but I find it very fascinating and interesting – the policy
debate going on involving immigration and some of the real world impact of
that policy debate.
Second: protecting a venturer’s trade secrets. Really I just want to touch
upon the importance in an entrepreneurial setting, or any small business
setting, of putting the right protections and measures in place to protect your
company’s secrets with respect to key employees and other stakeholders of
your business.
And last, again, I am just going to touch upon an area that I have some
familiarity with but certainly not expertise, which is compensation. I want to
just address a few of the trends in U.S. executive compensation.
I recently read a little report that was published by a company called
Interior Software Company. They were identifying some trends of small U.S.
businesses. One of the trends that they had identified was classifying what
they call a new breed of entrepreneurs, which they indicated would include
people who are near retirement age –
lot of people. This is meaningful coming from Detroit – displaced from
their jobs, leaving their jobs earlier than they had anticipated, earlier in their
careers and starting something new.3 More women are becoming
entrepreneurs.4
3
Institute for the Future, Intuit Future of Small Business Report, First Installment:
Demographic Trends and Small Business 3-5 (Jan. 2007), available at http://httpdownload.intuit.com/http.intuit/CMO/intuit/futureofsmallbusiness/SR1037_intuit_SmallBiz_Demog.pdf.
4
Id. at 7-8.
99
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[Vol. 33 No. 1]
Then the report also noted a continuing trend of immigrant entrepreneurs
as being one of the fastest growing segments in, certainly, small business
ownership.5 It attributed this to a number of factors, some of which may
include trying to steer around traditional barriers of employment when you
come to the U.S., including not having corporate contacts, English language
skill barriers, not having experience with large companies and really noting
that starting a business in some respects may be easier than trying to get a job
in your field in the US.6 The report went on to comment that the trend may
depend in large respect on how this policy debate plays out.7 I think that is
true to a degree. I think that whether or not immigrants to this country, or
even Canada, can come here and establish an entrepreneurial venture I think
is one topic.
One of the things in which I do see a potential problem is in establishing
U.S. ventures or entrepreneurs trying to get access to highly skilled workers
who are foreign born coming to the U.S. to work here, and the need for U.S.
companies to attract these highly skilled workers.
I am going to get to just one example. Before I do, I also want to note that
in Tab 3 of your materials – this is not material that was keyed for today’s
preparation – but there was additional data. I believe it was called Trend
Setter. And I noted in looking through it that in this Trend Setter barometer
data they had polled some CEOs of vast growing businesses, and that one of
the single most important challenges a business will face in 2007, number
one on that list, was finding and entertaining qualified employees.8
The data went on to mention the top three wild card issues in 2007: 47
percent mentioned a shortage of qualified workers.9 One example of this is
somewhat recent, and this is the H1-B visa shortage10, my term.
U.S. businesses use H1-B visas as a means of employing foreign-born
workers with specialized knowledge – scientists, engineers, and computer
programmers.11 Certainly, there are a myriad of other visa programs and
mechanisms for non-immigrants and immigrants alike to come to the U.S.
and work.12 I am not going to go through all of them in any degree, but I
5
Id. at 8.
Id.
7
Id. at 9.
8
PriceWaterhouseCoopers, TRENDSETTER BAROMETER: BUSINESS OUTLOOK 2Q 2007 3
(2007) available at http://store.barometersurveys.com/docs/2Q%202007%20Trendsetter
%20Business%20Outlook%20PricewaterhouseCoopers%20FINAL.pdf.
9
Id.
10
See Jared Leung, Understanding and Managing the H1B Visa Cap, INDUSTRY WEEK
(June 28, 2006), available at http://www.industryweek.com/ReadArticle.aspx?ArticleID=
12223.
11
Id.
12
See id. (listing five options, including hiring within US).
6
163
wanted to touch on this example as perhaps being illustrative of some
problems we have and how the policy debate needs to focus on it.
The key here for the H1-B visas is that there is an annual limit of 65,000
for new visas every year.13 These applicants have to have a B.A. degree, and
there are another 20,000 who have to have a U.S. Master’s Degree.14
Petitions are filed by U.S. businesses as of April 1st of every year for the
following fiscal year – U.S. Government fiscal year, October 1 through
September 20th.15 So there is really a rush to file.
The date this year was April 2nd, which was a Monday, and the U.S.
Citizenship and Immigration Services announced that they had received more
than enough petitions on that very day to satisfy the count for the entire
year.16 I just picked up the press release, and it is notes they had received
over 150,000 H1-B petitions on April 2nd, the day that you could actually
file, so the cap was reached.17 They will have a random selection process to
determine which cases are actually accepted, and everyone else will have to
wait another year.18 I think this is really an interesting problem.
Talking with Jerry before the program, I asked him how his company
deals with some of these issues. He said, well, you know, we are global and
have facilities in so many different parts of the world, and if we want to bring
people over here, there are other visa programs that might get by, the L1-B
for example.19 Or there may not be the need to bring workers over here to
make products if, in fact, you have the facilities abroad and are going to have
to hire workers there and make the product there.20
But if you are a U.S. business relying on skilled workers and you cannot
find enough in the United States, this is going to be a real issue. I think what
13
Id.
Press Release, U.S. Citizenship and Immigration Services, USCIS Update: Information
to Help Complete and Submit I-129 Petitions to USCIS Services Centers for FY 2008 H-1B
Cap Cases (March 27, 2007), available at http://www.uscis.gov/files/pressrelease/
H1B_I129Info_032707.pdf.
15
Id.
16
Press Release, U.S. Citizenship and Immigration Services, USCIS Reaches FY 2008 H1B Cap (April 3, 2007), available at http://www.uscis.gov/files/pressrelease/
H1BFY08Cap040307.pdf.
17
Id.
18
Id.
19
See Temporary Benefits Employment Categories and Required Documentation, U.S.
Citizenship and Immigration SERVICES, http://www.uscis.gov/portal/site/uscis/menuitem.
5af9bb95919f35e66f614176543f6d1a/?vgnextoid=229c6138f898d010VgnVCM10000048f3d
6a1RCRD&vgnextchannel=91919c7755cb9010VgnVCM10000045f3d6a1RCRD (last visited
Nov. 11, 2007) (delineating the guidelines for the L-1B intra-company transfer visa).
20
See Daniel Altman, Managing Globalization: Economies Have a Stake in Where
Companies Find Employees, INT’L HERALD TRIBUNE (June 6, 2006), available at
http://www.iht.com/articles/2006/06/13/business/glob14.php (describing how companies are
finding workers they need by sending work abroad).
14
100
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[Vol. 33 No. 1]
it says about the problem in the United States of U.S. citizens acquiring this
sort of specialization education is something for another day, but that’s
certainly a sub-theme in there.21
So there is an obvious barrier here to businesses in the U.S. that need
access to this skilled talent pool. Perhaps a little less obvious, but clearly
related, is the notion that this sort of policy, if it continues, may force U.S.
businesses to go abroad looking for this sort of skilled labor.22 So this is
perhaps another example of U.S. companies needing to go abroad, not
necessarily looking for cheaper labor, although that may be true as well, but
looking for the right sort of labor.
Particularly in industries and segments where the U.S. wants to champion
high-tech industry and the information and technology industries, economic
success is crucial.23 Now, I didn’t bring any hard and fast data for you on
whether this H1-B shortage has had a sort of doomsday impact, but I did
want to highlight for you something that is interesting. This is some
testimony by Bill Gates before the Senate Committee on Health, Education,
Labor, and Pensions. These were written comments submitted in March of
this year. And he – I wanted to highlight some other things he said, and I am
quoting:
America will find it infinitely more difficult to maintain its
technological leadership if it shuts out the very people who are most
able to help us compete. Other nations are recognizing and benefiting
from this situation. They are crafting their immigration policies to
attract highly talented students and professionals who would otherwise
study and work here. Our lost opportunities are their gains.24
Mr. Gates goes on to highlight what he sees as the illogic of encouraging
the best students from abroad to come over here and study and then taking
the exact opposite approach if they want to stay.25 He knows that, quote,
“Foreign students who apply for a student visa to the United States today
21
See Strengthening American Competitiveness for the 21st Century, Before the S. Comm.
on Health, Education, Labor, and Pensions, 110th Cong. (2007) available at
http://help.senate.gov/Hearings/2007_03_07/2007_03_07.html (statement of William H.
Gates, Chairman, Microsoft Corporation).
22
See generally Altman, supra note 20 (describing how US companies are already going
abroad in search of additional skill sets due to the dearth in the US).
23
See generally Bruce P. Mehlman, Assistant Sec’y for Tech. Policy, U.S. Dept. of
Commerce, Technology-led Development in the Post-Bubble, Post-9/11, Post-Enron America,
Address at the Louisiana Economic Outlook Conference (Nov. 15, 2002) (discussing why and
how technology is vital to Louisiana’s regional economic development).
24
Gates, supra note 21, at 10.
25
Id. at 10.
165
must prove that they do not intend to remain here once they receive their
degrees. This makes no sense.”26
So he is highlighting sort of the obvious problem. He also goes on to
address what I think is this notion of businesses needing to follow where the
talent pool is. He says,
Barring high-skilled immigrants from entering into the U.S., and
forcing the ones that are here because they cannot obtain a visa,
ultimately forces U.S. employers to shift development work and other
critical projects offshore. This can also force U.S. companies to fill
related management, design, and business positions with foreign
workers, thereby causing further lost U.S. job opportunities, even in
areas where America is strong, allowing other countries to “bootstrap
themselves” in these areas and further weakening our global strength.27
He concludes on that point by saying, in short, “[W]here innovation and
innovators go, jobs are soon to follow.”28
I think that’s true, and I think that this issue is an example of the real
tension here. We hear a lot in the policy debate about security issues,
border issues, and illegal immigrant issues.29 I certainly have not heard
much, or nearly enough, about issues of how this may impact specific
sectors, high-tech sectors, and access to skilled workers when U.S.
companies desperately want to bring such skilled workers over here.
This is being addressed. Potential reform for this issue is, as I said, being
carried out as part of the overall debate of immigration and is in Congress
right now.30 It is part of the STRIVE Act cap for H1-B visas.31 Under the bill,
they would go up.32 They would eliminate the 20,000 cap for persons with
26
Id. at 11.
Id.
28
Id.
29
See generally id. at 10 (describing that while national security and border security are
important policy goals, Mr. Gates believes they can be done in a way that would do less
damage to the US’s competitiveness and prosperity).
30
See, e.g., Protecting U.S. and Guest Workers: the Recruitment and Employment of
Temporary Foreign Labor, Before the Comm. on House Education and Labor, 110th Cong.
(2007) available at http://edworkforce.house.gov/hearings/fc060707.shtml (statement of
Jonathan P. Hiatt, General Counsel, American Federation of Labor and Congress of Industrial
Organizations) (discussing labor issues related to the immigration debate).
31
See generally id.
32
Summary of Security Through Regularized Immigration and a Vibrant Economy Act of
2007, NAFSA: National Association of International Educators 8 (2007), available at
http://www.nafsa.org/_/File/_/strive_summary.pdf.
27
101
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[Vol. 33 No. 1]
advanced degrees, and like any other sort of massive overhaul or purported
overhaul of any system, there will be political compromises, and there will
be other issues.33
So it remains to be seen how this particular sub-issue will play out, but
stay tuned because I think we will see more in the coming months. I did hear
one commentator say that if immigration reform is not addressed this year, it
is very unlikely that it will be addressed next year given presidential
politics.34
Other issues the commentators have indicated need to be addressed.
Certainly people who want to work here on a permanent basis are being
subject to unnecessary barriers at U.S. consulates or embassies abroad.35 The
tension, of course, is related to security concerns in the post-9/11 world.36
Now I am going to switch gears. I want to address the issue of restricted
covenants. I wanted to highlight the importance of restrictive covenants and
agreements with key employees and stakeholders in your venture,
particularly for a startup and the need for awareness.
Yesterday, I recall, Mr. Barber commented about entrepreneurship and
how it is inherently relationship driven. He mentioned that the market
doesn’t issue a PO. People issue POs. Fundamentally, we rely on people.
There is, or should be, a link between prosperity and ethics in the workplace.
Well, ethics is certainly – there is one form of honesty, pure and simple –
but the people aspects of entrepreneurship as a topic means, unfortunately,
that we will run into dishonesty and temptation in the marketplace. That’s
where you might find yourself talking to someone like John or myself.
I must say, as a litigator – and I was reflecting on another comment I
heard yesterday – that perhaps entrepreneurs and bureaucrats don’t mix, sort
of like oil and water. Well, I can tell you, entrepreneurs and litigators do not
make for a better combination either. The individuals that come to see me,
the small businesses I worked for grudgingly would come to me, and it
usually would be in one of two circumstances. One is where someone has
taken something from them, a trade secret or intellectual property or perhaps
33
Id.
See generally Farhana Hossain, Ben Werschkul, & Sarah Wheaton, The Presidential
Candidates on Immigration, N.Y. TIMES, Sept. 28, 2007, available at
http://politics.nytimes.com/election-guide/2008/issues/immigration/index.html (describing the
prior positions on immigration reform of likely presidential candidates).
35
See generally Jennifer Steinhauer, Austrian Interns Run Into U.S. Visa Problems, N.Y.
TIMES, Aug. 22, 2007, available at http://www.nytimes.com/2007/08/23/us/23holocaust.
html?partner=rssnyt&emc=rss (describing the problems an Austrian Holocaust museum
worker had obtaining a visa).
36
See NATL. COMM. ON TERRORIST ATTACKS UPON THE U.S., THE 9/11 COMMISSION
REPORT, available at http://www.9-11commission.gov/report/911Report_Ch12.htm (stating
immigration was not a national security matter before 9/11).
34
167
brought something to them that they were unaware of in the sense of hiring
someone who brought some knowledge and has unwittingly embroiled them
in a dispute.
But this is certainly an issue in the increasing and noble workforce and
the reality of the digital workforce. Gone are the good old days, perhaps, of
photocopying the company’s Rolodex and walking out with a customer list.
Now you just need a little zip drive, and you can download half the
company’s information, and you are gone. And commenting on being careful
when hiring, this works both ways. You need to be very careful and do your
due diligence when hiring employees, who may be bringing trade secrets.
Although you may not have done anything wrong, and may not end up being
a party to an inevitable lawsuit, it certainly would be a distraction if the key
employee just hired was now exposed to litigation risk. There is a myriad of
ways to deal with this, covenants not to compete, confidentiality agreements,
et cetera.37 I will just touch upon it very quickly.
Covenants not to compete are agreements between an employer and
employee where the employee agrees not to compete for a certain period of
time within a certain geographic or industry segment following leaving the
employer.38 Confidentiality agreement, it is just that. It is maintaining
company secrets.39 This may apply when you are dealing with someone who
may not be in a position to go out and compete with you after he or she
leaves your company, but nonetheless might be in a position to provide
company secrets in any event.
Non-solicitation agreements come in two forms: not to solicit customers
and not to solicit other employees.40 The former is harder to enforce, much
like non-competes, because it is, in some respects, an inherent restraint on
trade.41 Agreements not to solicit co-employees, may be a little bit easier for
the states to enforce.
Who needs this? Well, it depends. There is no one-size-fits-all. I say, at
the bottom, not the janitor.42 Believe it or not, we had a client come to us
recently, and they wanted to hire some painters for the summer. And they
wanted some non-compete agreements so that these student painters for the
37
See generally Victoria A. Cundiff, How to Protect Confidential Business & Technical
Information, 719 PRACTICING LAW INST. 85, 87-92 (2002) (describing the different ways
which a party can handle covenants not to compete and confidentiality agreements).
38
See BLACK’S LAW DICTIONARY 392 (8th ed. 2004) (defining non-compete covenant).
39
See 54A AM. JUR. 2D Monopolies and Restraints of Trade § 918 (2007).
40
See BLACK’S LAW DICTIONARY 1084 (8th ed. 2004) (defining non-solicitation
agreements).
41
See generally 2 LOUIS ALTMAN AND MALLA POLLACK, Callmann on Unfair
Competition, Trademarks, and Monopolies § 16:44 (4th ed. 2007).
42
See TAMMY HINSHAW, ET. AL., 54A AM. JUR. 2D Monopolies, Restraints of Trade, and
Unfair Trade Practices § 854 (2007).
102
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summer couldn’t go work for the competitor painting company for the
balance of the summer, and we said, “No, no, no. You know, that’s not going
to work. There is no protected interest there, and it wouldn’t be enforceable
anyway.”43
The key is that these need to be reasonable.44 Non-compete agreements
have problems all their own.45 Generally, courts are loathe to enforce them if
they perceive they are going to be un-employing someone who reasonably
believed that they were complying. This is the sort of answer that business
people can’t stand when they come to me as a litigator and they say, “Fine,
draft this thing for me. What do I need?”
Well, what’s reasonable then? Well, it depends. So if you want to talk
more about this with me, I will give you the “it depends” answer. Maybe we
can talk about what your business entails. Keep in mind these are contracts,
and so you need to check in your jurisdiction on what consideration is
necessary.46
If you are starting a job with an employer, it is easy. A non-compete can
be a condition for employment.47 If you want to inject a non-compete, you
can inject it. If you want to have existing employees sign one, it is a little
more difficult.48 In some jurisdictions, merely maintaining your employment
is consideration enough.49 In other jurisdictions, you need something else.50
There is an interesting problem, even in jurisdictions where maintaining
your employment is enough. Consider the situation where you are a startup
company. You are growing. You have ten employees, ten sales persons –
you want them all to sign. Nine sign without a problem. The tenth – let’s just
say he is your best employee – doesn’t want to. Now what do you do? Do
43
See generally RICHARD M. GALLAGHER, ET AL., 42 AM. JUR. 2D. Injunctions § 136
(2007).
44
LAURA DIETZ, ET AL., 17A AM. JUR. 2D Contracts § 326 (2007).
45
See generally Ann C. Hodges, Porcher L. Taylor, III, The Business Fallout from the
Rapid Obsolescence and Planned Obsolescence of High-Tech Products, 6 COLUM. SCI. &
TECH. L. REV. 3, 4 (2004-05) (describing how many commentators have recognized the
problem of lack of predictability in interpreting non-compete agreements and how
enforcement litigation is encouraged).
46
See generally Norman D. Bishara, Covenants Not to Compete in a Knowledge Economy:
Balancing Innovation from Employee Mobility Against Legal Protection for Human Capital
Investment, 27 BERKELEY J. EMP. & LAB. L. 287, 317 (2006) (“There is no uniformity in the
enforcement of post-employment non-competition agreements among states.”).
47
See generally Ferdinand S. Tinto, Annotation, Sufficiency of Consideration for
Employee’s Covenant Not to Compete, Entered into after Inception, 51 A.L.R.3d 825, 828
(1973) (stating that when the employee executes the covenant at the same time he accepts
employment, the latter becomes the consideration for the covenant.)
48
See generally id. (stating that some jurisdictions require additional benefits in
consideration for a non-compete covenant for a current employee.)
49
Id.
50
See id.
169
you fire that employee for not signing that covenant not to compete? That
may cause the very harm you are trying to avoid. Keep in mind this person
doesn’t have a non-compete yet. Yet, if you don’t fire that person, or don’t
take some steps, it may call into question the validity of those other nine.
It is one of these issues where it is tough to have it both ways. So that’s
something to keep in mind. Again, it depends upon the jurisdiction in the
United States how those are dealt with. In the event that you find yourself as
an entrepreneur without the right agreements in place, there are some
statutory protections: the Uniform Trade Secrets Act has been adopted in
nearly all states.51 It is fine to have these rights, but it is expensive to enforce
them.
Having the right agreements and the right protections also doesn’t prevent
someone from stealing your secrets, and it won’t ensure that you will not find
yourself in a lawsuit.52 But, at least, it gives you a framework to start to
enforce your rights that may, in some respects, be cheaper than trying to do it
merely through statutes.
As an aside, it can also be a criminal violation to steal trade secrets and
send them abroad.53 In Detroit last year, this is just a snippet from a press
release involving some former Metaldyne employees – Metaldyne is an
automotive supplier – and this is one of these horror stories where it plays
out sort of like a novel, where some former employees conspire with a
current employee to steal trade secrets and give them to, in this case, a
Chinese company.54 Metaldyne is in the powdered metals industry, and they
have a great deal of specialization.55
Metaldyne found out that something was going on.56 They sort of quickly
did an internal investigation.57 They put a package together and gave it to the
FBI who arrested these individuals who, by the way, were not that smart.58
51
Michael L. Rustad, The Negligent Enablement of Trade Secret Misappropriation, 22
SANTA CLARA COMPUTER & HIGH TECH. L.J. 455, 516 (2006).
52
See generally id., at 481 (stating that federal law enforcement lacks the resources to
successfully combat industrial espionage).
53
Id., at 465.
54
Press Release, U.S. Dep’t of Justice, U.S. Att’y, E. Dist. of Mich., Former Metaldyne
Employees Indicted for Theft of Trade Secrets (July 5, 2006), available at
http://www.cybercrime.gov/lockwoodind.pdf.
55
See id.
56
See generally Philip Burgert, Metaldyne Execs Accused of Selling Secrets to China,
METAL
MARKET,
Feb.
5,
2005,
available
at
AMERICAN
http://findarticles.com/p/articles/mi_m3MKT/is_44_113/ai_n9508273 (stating that the
incident came to light after Chongquing, a Chinese company formed by former Metaldyne
Vice President of Sales Anne Lockwood, requested a quote from International Truck &
Engine Corp. for equipment to make a new connecting rod prototype that had large metal
design components created by Metaldyne).
57
Id.
58
Id.
103
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There was access to their Yahoo accounts, which indicated, “Dear so and so:
Please put these files in this room where company A can get them. This is
just going to be great. There will be no way Metaldyne can compete after I
take this stuff.” I tried to find out what the results of this were and haven’t
been able to figure it out.
Very briefly, I just wanted to spend two minutes because that will, again,
exhaust my expertise, talking about some trends and executive compensation.
I think this is important for entrepreneurs to be aware of. Even though the
press and a lot of the regulations are dealing with CEOs of the large public
corporations, I think it is important for smaller and private companies to be
aware of the trends.
There were comments yesterday – I think it was David Woolford who
mentioned that a good entrepreneur is thinking like a public company in the
sense that, if you act public, you will be putting yourself in positions where
you are not surprising your stakeholders. Well, some of the regulations that
may impact executive compensation may, in fact, end up being best practices
for smaller companies or exempt companies.
Sarbanes-Oxley has had an impact. It has had boards of directors
delegating responsibility for executive compensation-to-compensation
committees of disinterested directors.59 Enron, again, we see an impact there.
You may know that many of Enron’s hiring executives received a substantial
amount of preferred compensation.60 They voluntarily terminated their
employment and elected immediate payments of their corporate deferred
compensation plans just before the scandal became public.61 So there are new
rules addressing the timing of when you can take advantage of that, and there
is a six-month timing gap to try to avoid some of these things.62
Changes in SEC proxy rules – I read some comments by the SEC
Commissioner that he composed in January of this year – and he just
59
See generally Dennis J. Block, Public Company M&A: Recent Developments in
Corporate Control, Protective Mechanisms, and Other Deal Techniques, 1587 PRACTICING L.
INST. 7, 151 (2007) (stating there is greater scrutiny of executive compensation due to the
adoption of Sarbanes-Oxley).
60
See generally Meredith Downes & Gail S. Russ, Antecedents and Consequences of
Failed Governance: the Enron Example, 5 CORP. GOVERNANCE: THE INT’L J. OF BUS. IN SOC’Y
584 (2007), available at 2007 WLNR 18643296 (stating that board members at Enron were
paid handsomely, and that Enron’s CFO Andrew Fastow earned $30 million from partnerships
enabled by Enron’s suspension of its code of ethics).
61
See generally id. (stating that Fastow, CEO Jeff Skilling, and twenty-seven other Enron
executives sold their shares before the company went bankrupt).
62
See generally id.; see also Roel C. Campos, Comm’r, Sec. Exch. Comm’n, Remarks
Before the 2007 Summit on Executive Compensation (Jan. 23, 2007), available at
http://www.sec.gov/news/speech/2007/spch012307rcc.htm (stating that new executive
compensation rules will have the effect of focusing executive compensation committees on the
details of executive compensation packages).
171
highlighted that the SEC’s focus is not going to necessarily interfere with the
level of compensation, but should be in order to make less of it, but just to
require more disclosure and more transparency.63
He gave a few tips regarding what boards should be thinking about
regarding compensation and benefit packages for key individuals. One was to
do your homework. As a compensation committee, he indicated that often
these committees are not doing a good enough job to really appreciate the
variations or the contingencies that may happen.64 How much money is
someone going to get when they walk out the door in various scenarios,
change of control, firing, service, insolvency? Some of the new SEC
guidance will require narrative explanations of what triggers these payments
and exactly the estimated amount.65 He was recommending negotiating teams
for companies, to try to inject a process here and involve disinterested
parties, decide what your parameters are, focus on long-term sustainable
performance for these employees and less upon short-term benchmarks and
really to focus on job jeopardy issues, service issues.66 What are people
getting when they leave?
He didn’t use this example, but I think many of us are aware of it: the
Walt Disney case, the Mike Ovitz case, where he was fired after fourteen
months and walked away with $130 million.67 All of us wonder; how on
earth can that happen? Well, it happened because that was the deal given to
him on his way in.
It was not money handed to him on his way out.68 Derivative litigation,
shareholder litigation, ultimately the Delaware Supreme Court concluded that
there was no breach of duty on the part of Disney there, but if you read the
opinion, you certainly get the sense, as I did, that they were kind of holding
their nose and voting for Disney as they say, begrudgingly saying that this
just looked like kind of a sloppy process – how this compensation was
decided.69
63
See id.
Id.
65
See id.
66
See id.
67
See generally James B. Stewart, Partners, THE NEW YORKER, Jan. 10, 2005, at 46,
available at http://www.newyorker.com/archive/2005/01/10/050110fa_fact_stewart (stating
that Disney paid Ovitz $140 million to settle his contract).
68
See generally Brehm v. Eisner, 746 A.2d 244, 244 (Del. 2000), and In re Walt Disney
Co. Derivative Litig., 825 A.2d 275 (Del. Ch. 2003) (Disney original shareholder’s derivative
suit and subsequent history, stemming from Disney’s $130 million severance package to
Michael Ovitz).
69
See generally Brehm, supra note 68 at 267 (stating that it is understandable that Disney
shareholders are upset over Ovitz’s package, but ultimately dismissing their complaint without
prejudice).
*
John Craig began his career as a law clerk to Chief Justice Antonio Lamer and Justice
64
104
172
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So I will conclude my remarks now and just as I did not attempt to do
throughout the presentation, I won’t try to tie all those three topics together.
But I wanted to highlight for you these are all people aspects of
entrepreneurs.
MR. TORMA: Ben, thank you very much. You did a remarkable job of
covering a myriad of topics in a short period of time. Thank you very much.
John?
MR. CRAIG: If I can do this.
MR. TORMA: While he is doing that, I will comment briefly on noncompetes and then later perhaps give a lay person’s view of them perhaps
from a different viewpoint; that it is just common sense – and it is not as
difficult as it could be – when you understand it is not just in the interests of
the company; it is really more in the interests, collective interests, of the
employees than just the company, and we can cover that later at this time.
Thank you.
John?
CANADIAN SPEAKER
John D. R. Craig*
MR. CRAIG: Thanks. It is a great pleasure to be here. My colleague, Stan
Friedman, who would otherwise be here but for a commitment that he could
not get out of, suggested that this would be a great opportunity for me to
share my thoughts on people issues to a joint Canadian-American audience,
and it sounded fun and interesting.
By way of background, I am a partner at Heenan Blaikie, which is a
Canadian law firm with a large management side employment practice. We
have offices across the country in Vancouver, Calgary, Toronto, Montréal
and smaller offices in Québec. We also act for North American and other
multinational corporations and we are allied with firms across the globe. My
practice includes both large and small American clients and I have a number
of Canadian clients who are in the entrepreneurial category.
Charles Gonthier of the Supreme Court of Canada in 1994. He joined Heenan Blaikie in 2001
after several years with another prominent Toronto firm. Mr. Craig practises exclusively in the
area of labour law at the University of Western Ontario, where he has been teaching since
1999. He is the author of Privacy & Employment Law (Hart Publishing, 1999), a book based
on his doctoral thesis. He has also published articles related to labour and employment law in
the McGill Law Journal, the Comparative Labour Law & Policy Journal, the Industrial Law
Journal, the Review of Constitutional Studies, the European Human Rights Law Review, and
the Canadian Labour and Employment Law Journal.
173
As Ben mentioned, this topic is somewhat of a grab bag, but I do want to
touch upon a few issues, namely doing business in Canada, employment law,
independent contractors, the importance of contracts, compensation, and
issues that arise when crossing the frontier between our two countries.
So first, the good news, there have been a number of recent studies
discussing issues of doing business and the cost of doing business. The
KPMG survey, “Guide to International Business Costs, 2006” indicated that
Canada has the second lowest business costs among the countries surveyed,
and Canada ranks behind only Singapore on employment and labor costs.70
There is more good news from a report entitled “Doing Business in 2006”:
Canada ranked number four in ease of doing business and number one in
flexibility and working time.71 This may be a surprise to those of us working
in Canada, since every other country has less working hours than we do.
What is notable, however, is that Canada ranks behind the United States in a
number of important factors, including the difficulty of hiring employees, the
difficulty of firing employees, and Canada ranks well below the United
States in the flexibility of employment.72 Therefore, expectations that small
American companies or entrepreneurs have based on their own systems will
not necessarily stand in good stead once they cross the border.
Now, the bad news: In my experience, entrepreneurs tend to approach a
lot of issues with a certain “Wild West” mentality, a “take no prisoners”
mentality. They try to find new ways to do things and sometimes that can get
them in trouble, particularly when they are dealing with a context they may
not be entirely familiar with. Moreover, they often do not have counsel or
consultants providing them with the advice that they require to be successful.
This leads me to a few points I would like to make on the topic of
employment law.
First, employment law in Canada is primarily a matter of provincial
jurisdiction. There are ten provinces in Canada, each of them having different
laws on employment issues.73 As a result, there are different laws:
employment standards, human rights, occupational health and safety,
70
KPMG LLP, COMPETITIVE ALTERNATIVES: KPMG’S GUIDE TO INT’L BUS. COSTS i
(2006), available at http://www.kpmg.ca/en/industries/cib/consumer/documents/
Competitive_Alternatives.pdf.
71
See THE WORLD BANK GROUP, DOING BUS. IN 2006, at 3 tbl.1.2 (2006) (stating that
Canada is number four in ease of doing business), and at 23 tbl.4.2. (stating that Canada has
the least amount of rigidity regarding work hours).
72
See id. at 22 tbl.4.1 (listing the U.S. as the third easiest country to hire and fire from;
Canada is not listed), and at 23 tbl.4.2. (listing the U.S. as having the third least rigid
employment environment; Canada is not listed).
73
See generally John-Paul Alexandrowicz, A Comparative Analysis of the Law Regulating
Employment Agreements in the United States and Canada, 23 COMP. LAB. L. & POL’Y J.
1007, 1028 (2005) (stating that Canadian workers are protected by a variety of provincial
employment discrimination laws).
105
174
[Vol. 33 No. 1]
workers’ compensation, and pension laws. There is only a narrow category of
employers who are regulated nationally, which include companies like Air
Canada and communication companies.74 Otherwise, the general rule is that
companies and employment relationships are regulated provincially.75 So, if
a company or entrepreneur wishes to employ individuals in Vancouver and
Toronto, they will be required to comply with two different sets of
employment laws, in British Columbia and Ontario.76
Second, there is no common law equivalent to the U.S. “at will” concept
in Canada. I understand “at will” to be the ability of an employer to fire a
person for any reason or no reason as long as it is done in compliance with
human rights laws.77 In Canada, it is true that you can be fired for any reason
or no reason, but an employer has to provide working notice to employees.78
This requires employers to give notice of a particular period of time or to pay
the employee for the notice they would have otherwise received.79 Typically,
employment standards legislation in various provinces will set out notice
periods. 80 In Ontario, which is probably the most relevant jurisdiction here,
the general rule under the statute is one week to a maximum of eight weeks.81
So if you have an employee who has been working for you for two years,
you are required to give him about two weeks of notice.82
This is where it becomes more complicated. My third point is that, in
addition to the statute, there is also a common law notice period.83 My
American clients refer to this as the “Canadian mystery notice period.”84 The
74
See generally Overview: Discrimination and Harassment: Federally Regulated
Organizations,
CANADIAN
HUMAN
RIGHTS
COMMISSION,
http://www.chrcccdp.ca/discrimination/federally_regulated-en.asp (last visited Oct. 14, 2007) (listing
Canadian federally regulated industries covered by the Canadian Human Rights Act).
75
See generally Alexandrowicz, supra note 73, at 1030 (stating that employees are
protected against discrimination on various prohibited grounds by provincial human rights
statues).
76
See generally id. (stating that individual Canadian employees have significant rights at
common law).
77
See Marc Cote, Getting Dooced: Employee Blogs and Employer Blogging Policies
Under the National Labor Relations Act, 82 WASH. L. REV. 121, 124 (2007).
78
Walter Stella & Patricia Forte, Employers Find a Different World Up (or Down) There:
Workers’ Rights Vary Dramatically North and South of the Border, THE NAT’L L.J., Apr. 18,
2007, available at http://www.law.com/jsp/ihc/PubArticleIHC.jsp?id=1176800663236 .
79
Id.
80
Id.
81
Employment Standards Act, 2000 S.O., ch. 41 (Can.).
82
See id. (requiring at least two weeks of notice if the employee’s period of employment is
one year or more and fewer than three years).
83
See Stella & Forte, supra note 78 (stating that there is no formula to calculate a
“reasonable notice” period in common law).
84
See generally id. (describing common law notice as “an art rather than a science”).
175
rule of thumb is about one month per year of service.85 So if an employee
decides to see you in Court because you fired them, you may be required to
pay them considerably more in damages than you would under the statute.86
For example, the employee who would get two weeks of notice under the
statute may be entitled up to two months or more of common law notice.87
This may be confusing because it is not written down anywhere.88 This is one
good reason why you need counsel in this area.
Finally, there is extensive statutory regulation. I suspect this is one of the
reasons why Canada ranks lower than the United States on flexibility of
employment. We have more extensive regulation in a number of areas
including occupational health and safety, in which we take a slightly
different approach, pension legislation and workers’ compensation.89
Additionally, there are many pitfalls.
Employment standards legislation sets this floor of rights.90 You can’t go
below the floor,91 you can’t contract out of it,92 and generally speaking, there
are no exceptions for small employers, including the entrepreneur class, who
may only have a very limited payroll or only a few employees.93 Generally
speaking, there is no exception.94
There are, however, a couple of areas where smaller employers are
exempted. One important area in Ontario is the severance obligation. This is
a separate obligation under Ontario legislation to pay employees for service
when you fire them.95 Generally speaking, it would be employees with five
years or more of service, and the employer has to have a payroll of $2.5
85
See id. (stating that judges and lawyers apply an unofficial guideline to assess the notice
period for employees who have a lengthy tenure of employment in the range of about one
month per year of service, but this guideline does not apply for employees with a shorter
tenure of employment).
86
See id. (stating that common law is often invoked to increase the minimum notice period
prescribed by statute).
87
Id.
88
See generally id. (determining common law notice on a case-by-case basis).
89
See THE WORLD BANK, DOING BUSINESS IN 2006: OECD-HIGH INCOME
REGION 13 (2005), available at http://www.doingbusiness.org/documents/2006-OECD.pdf
(ranking countries in OCED-high income region category, including the United States and
Canada, in Rigidity of Employment Index).
90
See
Ontario
Ministry
of
Labor:
Employment
Standards,
http://www.labour.gov.on.ca/english/es/ (last visited Nov. 10, 2007) (explaining that the
Employment Standards Act, 2000 sets out the “minimum standards” that employers and
employees must follow).
91
Id.
92
Employment Standards Act, supra note 81.
93
Cf. id. (omitting small employers from the Exceptions section to whom the Act does not
apply).
94
Id.
95
Employment Standards Act, S.O. 2000 S.O., ch. 41 (Can.).
106
176
[Vol. 33 No. 1]
million or more. So this is an exception available to a smaller employer or
entrepreneur just starting up in Ontario. Another example is emergency leave
entitlements. We have fairly extensive leave provisions in our employment
standards legislation96 that provide for ten days leave without pay due to
personal or family illness.97 This applies to employers with 50 or more
employees.98 Therefore, small employers and entrepreneurs starting out in
Ontario would not have to provide that benefit under the employment
standards legislation.99
I think the general rule is that employment standards are quite rigid. So
how do companies, American companies, American entrepreneurs and small
Canadian companies get around the rigidity? This brings me to my next
topic: independent contractors. Companies will say, given all of the
regulation that we are seeing across the country, “Why can’t we just make
everybody an independent contractor and avoid the whole spectrum of
employment laws?” I get this request all the time. And there are certain
advantages to doing this, including a higher degree of flexibility and often
tax advantages.100 Given these tax benefits, you may find people who would
be very happy to be independent contractors, at least at the initial stages. This
is a situation where everybody initially thinks this is a great idea, they call
me and I have to tell them that it is, in fact, a bad idea.
First of all, sometimes I find that clients, particularly those who do not
know a great deal about employment law in Canada, think they can avoid the
entire gamut of employment regulation by creating an independent contractor
situation. In fact, occupational health and safety legislation applies whether
people are employees or independent contractors.101 Human rights laws also
apply regardless.102 With respect to common law notice periods, there has
96
See generally Employment Standards Act, 2000 S.O., ch. 41 (Can.) (listing all the
different leave provisions, including pregnancy leave, parental leave, family medical leave,
and emergency leave).
97
Id.
98
Id.
99
Cf. id. (stating that an employee whose employer “regularly employs 50 or more
employers” is entitled to emergency leave of 10 days).
100
See Leanne E. Standryk, Contracts and Self-Employment: A Workforce Perspective,
Lancaster, Brooks & Welch LLP, http://www.lbwlawyers.com/publications/
contractandselfemployment.php (last visited Sept. 28, 2007) (describing the freedom of
independent contractors to decide whom to work for, when to work and how to work, as well
as their entitlement to business related tax deductions as advantages of being an independent
contractor).
101
See
generally
Health
and
Safety,
Ontario
Ministry
of
Labour,
http://www.labour.gov.on.ca/english/hs/ (last visited October 5, 2007) (explaining that the
Occupational Health and Safety Act sets out the rights and duties of “all parties in the
workplace,” including “every worker, supervisor, employer, constructor and workplace
owner”).
102
See generally Canadian Human Rights Act, R.S.C, ch. H-6 (1985) (stating that the Act
177
been recent case law that has confirmed that independent contractors may
also be entitled to reasonable notice of termination.103 So, if you fire an
independent contractor and you think you avoided your month per year of
obligation, you may be surprised to discover that, in fact, the independent
contractor still has entitlement.
The other problem is that you need a true independent contractor
relationship. What governs is substance rather than form. The fact that you
paper it as an independent contractor relationship is not going to suffice if, in
substance, what is really happening is a relationship of control where the
person is truly an employee.104 As a result, you may have an employment or
tax authority taking a look at your relationship and declaring that you have
not really created an independent contractor relationship. Penalties and
problems may arise.105
If you want to create independent contractor relationship in Ontario to
avoid rigid employment regulations that we in some cases have, the first
thing I tell my clients is that you have to create a non-exclusive
relationship.106 You cannot require an individual to work exclusively for you
and declare that they are an independent contractor.107 This is the essence of
the independent contractor; they work for a number of employers. That
usually stops the discussion. Most companies and most entrepreneurs want
exclusive relationships. For example, they do not want to have people on
their sales team who are able to go off and work for other employers. Some
of the other factors that are present in an independent contractor relationship
include limited control and supervision and ownership of tools (generally
independent contractors own their cars, their vans, their vehicles). Employers
cannot provide benefits to independent contractors.108 If you want to provide
extended healthcare benefits to your independent contractors, they are
extends to laws in Canada to give effect to the principle that “all individuals” should have
equal opportunity and should not be prevented from doing so by discriminatory practices).
103
But cf. JKC Enterprises Ltd. et al. v. Woolworth Canada Inc. et al., [2001] 300 A.R. 1
(Can.) (finding that notice is not required for independent contractors, but there are many
cases of an “intermediate nature” that are neither one of employer-employee relationship nor
employer-independent contractor relationship where a reasonable notice is implied).
104
See, e.g., Belton v. Liberty Ins. Co. of Canada, [2004] 72 O.R.3d 81 (Can.) (finding that
an employer-employee relationship exists where the employer exerted much control over the
agents, despite the explicit language of “independent contractor” in the employment
agreement).
105
Id.
106
See id. (identifying the question of whether or not the agent was limited exclusively to
the service of the principal as one of the four principles used to distinguish independent
contractors from employees).
107
Id.
108
See generally id. (describing an independent contractor as having an investment or
interest in “what are characterized as the ‘tools’ relating to his service”).
107
178
[Vol. 33 No. 1]
probably employees.109 Independent contractors typically invoice a business,
if you want to put them on payroll, they are probably not independent
contractors. So, in theory, independent contractors are a great idea. But in
practice, they are a bad idea.
Regardless of whether you are creating an employment relationship or
independent contractor relationship, it is extremely important to have a welldrafted contract. It is remarkable how many employers or principals in
Ontario do not have formal contracts. They have offer letters, very minimal
documents. I suppose this is done with the hope that it will work out, that
there will be no problems. However, the general recommendation that we
make to companies starting out is that they ensure their contracts are well
drafted and enforceable to avoid problems in the future.
What are some of the benefits of doing this? Well, the first benefit is that
it is possible to contract out of common law obligations that an employer
may have. The common law obligations in Ontario and other provinces are
more onerous than American common law obligations. If you are trying to
mirror more closely the American employment relationships, you need to
contract out of our common law.110 The notice period that an employer has to
pay upon termination is a very good example of an area where you will wish
to contract out. You need to do this explicitly. Be very clear because the
courts do not like you to contract out of common law, and they will try to
ensure that the common law survives and resurfaces unless you are very
clear.111
You can also use a contract to protect against competition and loss of
intellectual property. Often an entrepreneur is someone who has a new idea.
Is it an innovative idea? Is it some process, some invention that is being
brought across the border? The interest in protecting the intellectual property
and preventing competition may be very high. This is one of the reasons why
the contract, whether it is an employment contract or or a contract with an
independent contractor, needs to be crystal clear.
There has been a very interesting recent 2006 decision from the Ontario
Court of Appeals, IT/Net Inc. v. Cameron; it illustrates why you have to draft
your restrictive covenants as clearly as possible.112 What the employee did in
this case was not a very nice thing to do,113 and if the contract had been
109
Cf. Standryk, supra note 100 (stating that the independent contractor is not eligible for
employment insurance benefits).
110
See, e.g., McDonald v. ADGA Sys. Int’l Ltd., [1999] 117 O.A.C. 95 (Can.) (upholding a
contractual clause that rebutted the common law presumption of reasonable notice).
111
See, e.g., IT/NET Inc. v. Cameron, [2006] 207 O.A.C. 26 (Can.) (finding that the
employee did not breach the restrictive covenant in an employment contract because the
covenant goes beyond what is needed to protect the proprietary interest of the employer).
112
Id.
113
Id.
179
drafted clearly, the court would have upheld it and would have awarded the
employer damages for the employee’s competition and solicitation.114
However, the clause that the employer had drafted was too broad, had no
temporal limitations, no geographical limitations and a degree of
ambiguity.115 The court concluded that the entire non-compete clause should
be struck out.116 The employer tried as a fallback to argue that the employee
was a common law fiduciary who owed duties that would survive even if the
clause was struck out.117 The court did not agree.118 The employer had turned
its mind to this issue and, therefore, the clause was unenforceable. The
common law would not come to the employer’s rescue in this situation.119
Even though the court was willing to concede what the employee had done
was improper and could have been prevented by a contract, the court was not
willing to award damages. So, the lesson is that the restrictive covenant must
be drafted as clearly as possible in order to be enforceable.120 Otherwise, it
will be struck out, and the employer will be out of luck.
A few comments on compensation issues: The governing principles that
tend to apply when companies are starting out are those of maximum
flexibility and maximum discretion with respect to compensation. However,
as Ben pointed out, attracting good workers and retaining them is very
problematic in the current economy. So it is important for compensation to
be competitive and to be consistent with the market.
I have had situations recently where I can honestly say that I felt my
clients were being held hostage by employees who were so crucial to their
operations that they could not afford to lose these employees. I will give you
an example. One of my clients recently was in renegotiations with a CFO.
This was a very small company, very entrepreneurial. The CFO wanted a
golden parachute. She said, “If you fire me for any reason or no reason, I
want $100,000. If I decide to quit, I want $100,000.” My client called me and
said they were thinking of agreeing to this because they hoped the clause
would be unenforceable by a court due to unconscionability. First of all, I
asked them why they would pay anybody $100,000 for resigning. As soon as
the employee signs the contract, she is going to quit and it is like winning the
114
See id. (holding that the restrictive covenant goes beyond what is needed to protect the
proprietary interest of the employer, but it would have been entirely reasonable if it simply
prohibited the employee from assisting employer’s competitor to obtain a contract with a
client of employer to fill the very position he had occupied with that client).
115
Id.
116
Id.
117
Id.
118
Id.
119
See id. (holding that a restrictive covenant was unenforceable because it was not
reasonable).
120
Cf. id. (holding an ambiguous restrictive covenant unenforceable).
108
180
[Vol. 33 No. 1]
lottery. Why would they agree to that? Second, they are the employer. I do
not think that a court is going to come to their rescue and find that this is
some kind of provision contrary to public policy. I told them to rethink their
position. If you can believe it, this employee was so valuable to the company
they agreed to the $100,000. It is in the contract. I am waiting to see what’s
going to happen, whether the CFO will simply quit next week, take her
money, and run. That is an example of being held hostage because an
employer is so reliant on a particular employee that they cannot afford to lose
her.
We always think of employment as being this imbalance of power, and
99% of the time it is. The employer has all the cards, imposes the working
terms and conditions. However, in rare cases, it works in reverse and the law
does not contemplate this.121 In fact, our Supreme Court of Canada has
repeatedly said that it is a legal assumption that there is an inherent balance
of power in every employment relationship.122 It is probably true in most
cases, but I have seen examples where the assumption does not hold. I do
find that some people or employers can be held hostage in certain cases.
One of the good things for employers is the availability of the public
healthcare system across the country. This means that healthcare is not a
benefit that needs to be provided and not a basis upon which to attract
employees.123 Many employers will provide extended healthcare benefits
such as dental, vision, drugs, etc. However, small companies starting out do
not usually offer these kinds of benefits because they are quite expensive.
The message that I have given to my clients who are starting up in Ontario, is
to hold off on significant benefits. However, it is worthwhile to discuss the
issue with consultants to find out what’s being offered in any particular
industry.
There may also be a benefit to be gained from considering employer
contributions to RRSP, which is our individual pension plan,124 rather than
providing an employer-sponsored pension plan. Consider providing some
121
See generally Janis Sarra, Labour Arbitration: Recent Developments in Judicial Review
of Arbitration Decisions, Dancing the Two-Step in British Columbia, 36 U.B.C.L. REV. 311,
311-12 (2003) (describing collective bargaining as a means through which unions enhance the
terms and working conditions of employees, where the labor relations law recognizes the
“inherent imbalance in power” between employers and employees).
122
See, e.g., Wallace v. United Grain Growers Ltd., [1997] 3 S.C.R. 701, 741 (Can.).
123
See generally Canadian Health Care, http://www.canadian-healthcare.org/ (last visited
Nov. 10, 2007) (stating that Canada’s public health care system is provided to all Canadian
citizens); cf. Sherry A. Glied & Phyllis C. Borzi, Devising Solutions: The Current State of
Employment Based Health Coverage, 32 J. L. MED. & ETHICS 404, 404 (2004) (explaining
that during and after World War II, American employers sought to attract workers by offering
health insurance in lieu of wage increases).
124
RRSP
–
Glossary,
Canada
Revenue
Agency,
http://www.craarc.gc.ca/tax/individuals/topics/rrsp/glossary-e.html (last visited Nov. 10, 2007).
181
sort of flexible and efficient benefit that satisfies employees’ pension needs.
Employment lawyers can certainly help to create this. It is also important to
consult with tax lawyers to determine the tax consequences of offering
certain benefits rather than others.
I will now talk about crossing the border. It seems to me there are three
scenarios that need to be considered. First is those individuals immigrating to
Canada to become entrepreneurs. Second is Americans entering Canada to
conduct business with the intention of returning to the U.S. after a short visit.
Third is employers wishing to transfer employees to Canada.
Now, I would have thought that the idea of people immigrating to Canada
as entrepreneurs from the U.S. would be a fairly rare occurrence, but last
night as I drove in from the airport, my cab driver asked me where I was
from. When I told him I was from Canada, he proceeded to tell me that he
and his cousin in South Asia were thinking of establishing a PVC pipe
business in British Columbia, and he would be moving there if this plan went
ahead. He is an American citizen. I was convinced that the conference
organizers set me up because it was just too much of a coincidence.
MR. JEFFERS: He needed investors.
MR. CRAIG: He had an idea that PVC would be great in the Vancouver
climate, as it is similar to Seattle where a lot of PVC is needed. So there was
an American entrepreneur who told me that he was thinking of moving to
Vancouver. Naturally, I explained the requirements to him.
One of the things I thought was notable is that there is an entrepreneur
class of immigrants. One has to commit to $300,000 of investment in the
country,125 and it takes between 36 to 48 months, or three to four years before
an entrepreneurial application will be processed.126 I would have thought that
an entrepreneur who wanted to come to Canada would lose interest quickly
given the application time.127 I wanted to investigate a little further because I
find it hard to believe that we could have a system that is so inefficient. I
have been told that only a thousand people have come in the last few years
under this program.128 Perhaps this is one of the reasons why.
125
See generally Entrepreneurs: Definitions, Citizenship and Immigration Canada
http://www.cic.gc.ca/english/immigrate/business/entrepreneurs/definitions.asp (last visited
Nov. 10, 2007) (stating that an entrepreneur must have a legally obtained minimum net worth
of $300,000).
126
See generally Canada Business and Investment Immigration Overview,
http://www.immigration.ca/permres-business-overview.asp (last visited Nov. 10, 2007)
(explaining that the federal entrepreneur program application processing delays regularly
exceed 2.5 years).
127
See id. (stating the years of application processing delay).
128
See generally CITIZENSHIP AND IMMIGRATION CAN., ANNUAL REPORT TO PARLIAMENT ON
IMMIGRATION 2006 18 (2006), available at http://www.cic.gc.ca/english/pdf/pub/
immigration2006_e.pdf (reporting that the number of permanent residents in the Entrepreneurs
Class for 2005 was 2,848).
109
182
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The more common scenario is Americans crossing the border to conduct
business for a day or a week and then returning. Our system is relatively
flexible on this front. There are visas that can be obtained, and many of you
are probably aware of this process. Where this becomes complex, it is
important to have immigration consultants to assist you. I recently had a
client in the U.S., an American media company, who was sending two of
their journalists across the border to Toronto. The complicating factor was
that both of these employees were minors and their parents were not able to
travel with them. We had to figure out how we can get two 16 year-olds
across the border with only two days notice. Finding the answer quickly was
quite difficult because we found the materials that the immigration
authorities in Canada provided to be impenetrable. There was a form that
required the parents to grant consent and transfer guardianship of these two
teenagers to a representative of the company for a narrow period of time. If
something happened and these two teenagers had to stay in Canada longer,
another form was required. The process was very complicated. The bottom
line is to consult with experts when necessary.
Thank you very much.
DISCUSSION FOLLOWING THE REMARKS OF BENJAMIN W.
JEFFERS AND JOHN D. R. CRAIG
MR. TORMA: John, thank you very much. It was an excellent
presentation.
The closing comment is to remind us that we need to use the legal counsel
that is available. We may ask ourselves, gee, isn’t that rather expensive?
Well, I use the analogy that education is expensive. The only thing more
expensive than education is ignorance. So I think we would be penny wise
and a pound foolish not to take that advice.
Are there any questions, a few comments? Let’s see first from the
audience if there are any questions.
Henry?
DR. KING: Yeah. I wanted to get the comments on the duration of noncompete clauses both in Canada and the United States. What is a reasonable
point in time for a non-compete clause?
MR. JEFFERS: I won’t give you the “depends” answer, but I will say if
you are in a fast-moving industry where there is a lot of change, a lot of
innovation, maybe six months in some jurisdictions would be considered
reasonable.129 That may be all that you really need in terms of trying to keep
129
See, e.g., DoubleClick, Inc. v. Henderson, No. 116914/97, 1997 N.Y. Misc. LEXIS 577,
at *23 (Sup. Ct. N.Y. Nov. 5, 1997) (enjoining defendants for six months because a one year
restrictive covenant was too long given the dynamic nature of the internet industry).
183
a key former employee from competing against you; other industries, maybe
a year.
I think as a rule of thumb in some of my – and some of my employment
colleagues probably would agree with me – anything more than a year I think
the court is really going to look at very closely, and you would have to have a
very good reason.130
MR. TORMA: I would like to make a comment on it, if I may, absolutely
non-legal, more from a practitioner’s viewpoint. Nordson Corporation makes
industrial application equipment.131 As I indicated, we started with painting
equipment, electrostatic for the most part, and now powder paint
equipment.132 That’s about one third of our business.
Two thirds of our business is packaging, basically closing, sealing boxes,
applying glue to products, et cetera, et cetera. So we are a relatively
sophisticated but fairly not high-tech and not that fast moving technology.
Over the more than 50 years that we have put in non-compete agreements,
we have evolved, and it is different by country. But the U.S. and Canada are
almost similar, and it is basically as we heard here, it is a matter of common
sense, and it is a matter of reasonableness.
And the four factors that we keep in mind – and it has worked very well
for us – as we heard about is, one, geographic scope. So if a person is a sales
person, we normally restrict it only to the person’s current geographic scope.
And that has been seen as relatively reasonable by a court of law.133
The second one is the functional scope of how broad it can be. If a person
is a sales person in a particular product line, we are very careful with that
product line because in this day and age with the Internet, there is a lot of
information that is already public domain. So we are only concerned about
that which is not. So number one, it is a limited geographic scope.134
130
See, e.g., Captain & Co., Inc. v. Towne, 404 N.E. 2d 1159 (Ind. Ct. App. 1980) (holding
a two-year covenant not enforceable).
131
Nordson Corporate Profile, http://www.nordson.com/Corporate (last visited Nov. 10,
2007).
132
Nordson History, supra note 1.
133
Compare New River Media Group, Inc. v. Knighton, 245 Va. 367 (Va. 1993)
(upholding a non-competition agreement that prohibited employee from engaging in
competing business within sixty air miles of former employer’s radio station where the radius
of the station’s signal strength was sixty air miles) with Alston Studios, Inc. v. Lloyd V. Gress
& Associates, 492 F.2d 279 (4th Cir. 1974) (holding that a non-competition covenant was
overbroad both as to geography and the activities of future employment in that it encompassed
activities in which defendant was not engaged).
134
Ann C. Hodges & Porcher L. Taylor, III, The Business Fallout from the Rapid
Obsolescence and Planned Obsolescence of High-Tech Products: Downsizing of
Noncompetition Agreements, 6 COLUM. SCI. & TECH. L. REV. 3 (2005).
110
184
[Vol. 33 No. 1]
Number two, it is a limited functional scope.135 So if it is translated back
to our product, if it is a glue application or adhesive application sales person,
we narrow it down to probably just packaging as that is their specialty.
The third one is the length of time, and ours is almost always two years in
the U.S. and Canada, different in different countries. I quickly go to the
fourth one because it backtracks with the third one. What compensation is
there in order to make it reasonable?
It would not be reasonable – and I am not an attorney, but it just makes
sense that it is not reasonable – if you just prevent a person from working.
What we do is, say, for up to two years, if that person makes a good faith
effort to find a job and is not able to do so outside of the non-compete
regulations, we will pay them 75 percent of their compensation for up to a
two-year period based on a track record they have been looking for another
job.136 And that package, except for Minnesota one time, which we fixed
that, other than that, we are pretty much in good shape in both the U.S. and
Canada.
MR. SHANKER: How do you deal with former employees stealing your
customers?
MR. TORMA: Okay. I would like to defer that to the attorneys if they
don’t mind.
MR. CRAIG: I have two categories of clients: the client who wants me to
draft non-compete provisions who never intends to enforce them, they simply
want to have them as deterrence. They will say, “We never would enforce it
so make it five years.” This is one attitude. The other client feels that noncompete provisions are important and do not want to risk losing business.
Generally speaking, non-compete provisions are unenforceable unless
they are reasonable.137 A non-compete provision will not be reasonable if a
non-solicitation clause would be sufficient to accomplish the employer’s
objectives.138 As a result, you only have a narrow category of employees who
truly can be subject to non-competition provisions. In this category are those
who are the face of the company. If they were to leave the company, clients
would follow. One of the key cases that we have on this point involved a
partner in an actuarial firm.139 I should point out, that the court said that the
rules apply similarly in employment. The partner had been at the firm for a
long time and was subject to a non-compete provision. When she left, all of
135
Id.
See generally id. (stating that employers should consider providing severance pay to
employees in order to reduce litigations arising from non-compete agreements).
137
Lyons v. Multari, [2000] 50 O.R.3d 526, 531 (Can.).
138
Id. at 534.
139
Towers, Perrin, Forster & Crosby, Inc. et al. v. Cantin et al. (1999), 46 O.R. (3d) 180
(S.C.J.)
136
185
her clients followed her. The court held that she was the kind of person who
could be restrained by a non-compete provision because clients will simply
follow her no matter what. So, generally speaking, I would think that for a
person of that nature, 24 months would be the upper limit.
The point that Jerry made is very important because if you want to have a
non-compete that is longer than that, you are probably going to have to
provide compensation during that period of time. You may well be able to
get away with compensation paralleling the length of the non-compete
provision because there is very strong consideration for the limitation.140
MR. JEFFERS: I forgot the question. How do you prevent employees
from stealing customers?
MR. SHANKER: yeah. That was – goes back decades ago that was our
concern. Sometimes they take your customers with them, and sometimes the
customers want to go, and how do you deal with that problem?
MR. JEFFERS: Yeah. It is very difficult, and I will be honest, in many
instances you just can’t solve that. You can try to enter into a non-solicitation
agreement with an employee where they are agreeing not to solicit your
customers for a period of time. That’s going to be analyzed much along the
lines of a non-compete because it has the functional equivalent.
In terms of whether there is any sort of inherent protection to your
customer list, it would depend upon whether your customer list was
considered a bona fide trade secret.141 And under the Uniform Trade Secret
Act, which has been adopted in most of the states in the U.S., a trade secret is
sort of information or a pattern, a compilation that derives independent
economic value, actual or potential, from not being known or ascertainable
by proper means by others who could gain value.142
Now, essentially what that means, if this is just a public list, forget it. If
your customers – if we are in Detroit and you are an automotive supplier and
your customers are OEMs, there is absolutely nothing to seek further
proprietary about that customer list. If you are in an industry where given the
nature of your products or processes you have actually developed specific
contacts and sort of niche customers, then perhaps you might get some
protection. That’s sort of the legal answer.
From a nuts and bolts perspective – and this goes to just stealing any sort
of company secrets – some of the advice we give if you are letting an
employee go is to do a couple things. First, do an exit interview. Don’t
140
See generally Hodges & Taylor, supra note 134 (explaining that a provision for
severance pay would greatly reduce litigation).
141
See, e.g., Holiday Pacific Ltd. v. Valhalla Custom Homes Ltd., [1990] 29 C.P.R.3d 1
(Can.) (finding that a customer list was information that the defendants would have been
aware just from their employment, and as knowledge of an employee is not a trade secret, the
court held for the defendants).
142
Unif. Trade Secrets Act § 1(4) (1985).
111
186
[Vol. 33 No. 1]
discount the value of sitting in an office face to face with someone and
asking, “Have you taken – are you taking anything as you walk out the
door?”
If the person is dishonest enough to have stolen something, they may
continue to be dishonest, but you may learn something during the course of
that interview that at least raises some red flags. We suggest that you
reaffirm to that employee what their agreement is, provide them sort of a
reminder letter or perhaps even get them to sign it – that they received this
reminder letter.
As a practical matter, in this day and age, I think one of the first steps that
a lot of employers are going to do is they will have the IT department access
and assist them in trying to determine whether or not that employee has
downloaded any information.
There is an electronic paper trail, as it were, if you are copying data, and
there would be what they call a meta data trail, for example, on April 9th at
10:33 in the morning, user No. 3936 copied the following files from the
database. And so those are things where immediately you can try and
ascertain whether there is a pattern here and something that looks odd.
MR. TORMA: In addition to our non-competition clause, our
employment agreement has two other key clauses. One of those deals is right
of invention, and we won’t deal with that, and the other one is
confidentiality.
And we will consider customer data, certain aspects of that, confidential.
Even the reference was to ongoing companies – we had a case where they
were selling to the Big Three, then the fact it is the Big Three is not the issue.
Who the contacts are, whether they are e-mail addresses, the telephone
numbers, but more importantly, what have they bought from us, and what
prices with what contractor and so on.
And we do address that, and we do exactly as Ben recommended, and we
remind them when they are going out the door, we send them a copy of their
employee agreement, reminding them they signed that, and it is still valid,
certain aspects of it for certain periods of time.
If it is a service type situation, which most of the time it is not, it is
voluntary resignation, then there is an agreement, and part of that agreement
is acknowledgement of their employment agreement. It is not always
working, but for the most part, if you remind them they did sign it and for a
period of time there is a sensitivity there, usually in our business three to six
to nine months is sufficient for the information to be old enough for us to get
in there with the contacts and do a peremptory strike; remind them that we
can do that.
So again it goes to reasonableness and preparation in my opinion. I think
there is another question.
187
MR. GROETZINGER: John, you had talked about entering Canada as an
entrepreneur, and I am wondering then, if you knew of any visa classification
where a Canadian or foreign citizen could enter the U.S. as an entrepreneur,
given the fact as we started this conference yesterday, that entrepreneurship
is the lifeblood of an economy. If not, what has been the rationale for the lack
of that?
MR. CRAIG: That is a good question. Canadians are visa exempt under
many classifications.143 There are many programs and means by which
Canadians can come to the U.S. to work, and, therefore, the H1-B visa issue
may not impact the ability of U.S. companies to obtain highly skilled
employees from Canada.144 There is also the NAFTA visa status, whereby
many individuals from Canada and Mexico can come to the U.S. fairly easily
under a NAFTA visa.145 There are 20 to 30 various classifications and
programs146 including visa exempt147 and visa waiver programs.148 Canadians
do not face the same barriers when entering the U.S. that others face, such as
employees coming from India or China.
MR. TORMA: What we are seeing coming from Eastern Europe, some of
our former customers and others – in fact, one of my very first interns from
Poland, who was with us in 1993, recently came to the U.S. with his family
on an investor visa – and the threshold was much lower than I expected it to
be. I want to say E-4 as indicated, but I am not sure, but if you let me know, I
can certainly point you in that direction.
But the investor visa was a lot lower than I thought it would be, and I am
seeing some entrepreneurs from Eastern Europe beginning to use that.
Question up front. We have five minutes left, probably two questions.
DR. BARBER: The discussion about common law, which John gave us, it
gave me the impression, a good impression that law always and its clauses
cover all the things that people can do or think about doing, and so there has
to be a kind of common sense and reasonableness characteristic to the
practice of law, I suppose.
143
Who from Canada, Mexico and Bermuda, Needs a Nonimmigrant Vista to Enter the
United States Temporarily, U.S. Dept. of State, http://travel.state.gov/visa/temp/without/
without_1260.html (last visited Nov. 10, 2007).
144
See id. (stating that Canadian citizens do not require a nonimmigrant visa to enter the
U.S.).
145
See Mexican and Canadian NAFTA Professional Worker, U.S. Dept. of State,
http://travel.state.gov/visa/temp/types/types_1274.html (last visited Oct. 14, 2007).
146
Nonimmigrant
Visas,
U.S.
Citizenship
and
Immigration
Services,
http://www.uscis.gov/portal/site/uscis/ (last visited October 16, 2007) (follow “Education and
Resources” hyperlink; then follow “Visa Resources” hyperlink; then follow “Nonimmigrant
Visas” hyperlink).
147
NAFTA, supra note 145.
148
Id.
112
188
[Vol. 33 No. 1]
But the question that I have is: it sounded as though for the example you
gave that, while common law of that sort with that kind of flexibleness or
lack of definition, if you like, may actually be applicable, it sounded to me as
though the courts don’t have the option of using reasonableness and common
sense in their decision, and so my question was: would they have been better
not to have any kind of contract than to have one that didn’t anticipate all the
things that people could do because the courts can’t rule on the basis of that
kind of contract using the common sense and reasonableness?
I don’t know if I am clear about what I am trying to get at.
MR. CRAIG: The problem arises because there are certain aspects of the
common law as it relates to employment that are unfavorable to
employers.149 My view is that the courts are very concerned about the
vulnerability of employees, and assuming this to be the case, they tend to err
on the side of the employee.150 Employers, therefore, must be very careful
about how they frame contracts. The point I made is that if the contract fails
in some respect, such as a covenant that is too broad, it may be struck out.151
What you are left with is a default position that is unfavorable to the interest
and concerns of the employer. That is why contracts have to be drafted
carefully by someone with legal expertise. That being said, I do not want to
leave you with the impression that the courts avoid a common sense
approach; I think judges do understand the realities of the world. Virtually all
of the major courts in the country have very prominent former labor lawyers
who understand the realities and make an effort to ensure that the law
evolves in a realistic way.
MR. TORMA: Before we get to our last question, very quickly, I would
like to ask Ben to give us the nomenclature and quick executive summary of
the treaty investor visa information that he found was off by two numbers.
MR. JEFFERS: Yeah. It was very good by the way. I think he was
referring to the E-2 treaty investor in which someone would enter the U.S.
solely to develop or direct operations of an enterprise, which a foreign
employer has an active and substantial investment in.152 So the individual
149
See, e.g., Lyons, supra note 137 at 531 (stating that non-competition provisions are
unenforceable unless they are reasonable).
150
See, e.g., Wallace v. United Grain Growers Ltd., [1997] 3 S.C.R. 701, 741 (Can.)
(holding that the law should be mindful of the vulnerability of terminated employees and
ensure their protection by encouraging proper conduct and preventing all injurious losses
which might flow from acts of bad faith or unfair dealing, despite concerns that this imposes
an onerous obligation on employers).
151
See Hodges & Taylor, supra note 134 (stating that in states where courts cannot rewrite
agreements that exceed the bounds of reasonableness, the covenant may simply be
unenforceable).
152
Treaty
Traders
and
Treaty
Investors,
U.S.
Dept
of
State,
http://travel.state.gov/visa/temp/types/types_1273.html# (last visited Nov. 10, 2007).
189
that would be coming to the U.S. must have a significant or a managerial
role, and that’s a one-year visa.153 So that’s a means for entrepreneurs in
Canada who have established businesses there.
MR. TORMA: Last question, Steve Petras from Baker Hostetler.
MR. PETRAS: I believe last time I looked under Ohio law – and I am not
an employment lawyer – the Ohio Supreme Court allows what they call
“blue-lining.” If your clause is too restrictive, the court can pare it back to
something that is reasonable.
Is it true in Ontario or Canada? Do the courts do that? What if you had a
clause in your contract that said, “We are too broad. Cut us back”?
MR. CRAIG: According to the Ontario Court of Appeals in the case I
mentioned earlier, they are not prepared to do that.154 You would have to
have a severability clause,155 which provides that if a non-compete provision
is too broad and therefore struck out, a non-solicitation provision would still
be enforceable.156 In this way you will get to the same result, however,
judges will not do it for you.
MR. TORMA: Thank you to Ben and John, and to all of you for
participating. Excellent questions. Excellent questions.
153
Id; see generally Treaty Trader & Treaty Investor, U-S-A Immigration.com,
http://www.u-s-a-immigration.com/INS/treaty_trader_visa.htm (last visited Nov. 10, 2007)
(explaining that the initial “E” visa period is for the term of one year, although the visa can be
extended almost infinitely).
154
IT/Net Inc., supra note 111.
155
See, e.g., Globex Foreign Exchange Corp. v. Kelcher, No. 050108056, 2005 ABQB 676
(Alta. Q.B. Sept. 7, 2005), available at 2005 AB.C. LEXIS 1489 (employing severance where
the agreement included a severability clause).
156
Cf. id. (upholding the non-solicitation provision and modifying the overbroad restrictive
covenant to a reasonable level).
113
THE IMPORTANCE OF VENTURE CAPITAL IN PROMOTING
ENTREPRENEURSHIP
Session Chair – Daniel Sandler
Canadian Speaker – Brad D. Cherniak
United States Speaker – Cathy Horton-Panzica
INTRODUCTION
Daniel Sandler
DR. SANDLER: All right. Welcome back, everybody. Thank you very
much for joining this session on the Importance of Venture Capital
Promoting Entrepreneurship. Yesterday we heard a lot about the importance
of entrepreneurship to the economy, and I think it is useful to go over some
of the stats that we heard yesterday about the importance of small businesses
to the economies in both Canada and the United States because the statistics
are actually quite similar in both countries. In both countries, small
businesses make up 99 percent – more than 99 percent – of all employers.1
They employ about half of all employees in the country.2 They significantly
outperform large corporations in terms of job creation, and they carry on a
significant amount of research and development.3
But, and this is an important but, as indicated yesterday, particularly in
the Government session, not all small businesses are the same. A significant
1
Kenneth Hendricks, Raphael Amit, & Diana Whistler, Business Taxation of Small and
Medium-sized Enterprises in Canada, at 1 (Canadian Technical Committee on Business
Taxation, Working Paper 97-11, 1997) available at http://www.fin.gc.ca/taxstudy/wp9711e.pdf (Canadian figures supporting the small business statistics); see also SMALL BUSINESS
PROFILE: UNITED STATES, UNITED STATES SMALL BUSINESS ADMINISTRATION OFFICE OF
ADVOCACY 2 (2004), available at http://www.sba.gov/advo/stats/profiles/04us.pdf (chart of
number of employer firms in the United States).
2
Id.
3
See generally HANS LANDSTROM, PIONEERS IN ENTREPRENEURSHIP AND SMALL BUSINESS
RESEARCH (Springer 2005), available at http://books.google.com/books?id=20X5XlJjzkYC&
pg=PA150&dq=pioneer+entrepreneurship+and+small+business+research&sig=zPoglLbAPe3RZjAfAJ_HQ2ik4c.
191
114
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[Vol. 33 No. 1]
distinction has to be drawn between what I refer to as lifestyle businesses and
rapid growth small businesses, sometimes referred to as “gazelles.”4
The vast majority of small businesses, over 90 percent, are lifestyle
businesses.5 They do not tend to be technological innovators or job creators.
The most important small businesses in terms of economic development are
gazelles, and they make up only four to eight percent of all small businesses.6
But it is these small businesses that are the important job creators,
accounting for 70 to 75 percent of net new jobs.7 These small businesses,
particularly today, are concentrated in the high-tech sector, and despite their
growth potential, these small businesses have the greatest difficulty attracting
capital, particularly from traditional sources such as banks.8
They have long startup periods, and at their earliest stages, the only asset
that these companies have in many cases is the intellectual capital of their
founders.9 These are not ideal circumstances for bank financing. Venture
capital is fundamentally important for these companies. Consider companies
like Hewlett-Packard, Apple, Microsoft, Netscape, and Google – these are all
household names and all these companies got their start from venture
capital.10 The venture capitalist is willing to invest in startup companies. The
rewards can be great, but the risk, as we heard about yesterday, can also be
great.
I just want to stop and take a little informal poll that I think would be
helpful for those on the panel. How many people here would call themselves
entrepreneurs? Okay. And how many people are venture capitalists? All
right. Well, for those that aren’t venture capitalists, how many ever put
money into a family business or a friend’s business or an acquaintance’s
4
Jere W. Glover, Small Business Finance in Rural and Urban Regions, OFFICE OF
ECONOMIC RESEARCH IN THE OFFICE OF ADVOCACY, at 168, available at
http://www.sba.gov/ADVO/stats/fedsbfin.pdf.
5
See George Rodriguez, Making a Profit Out of Passion: Lifestyle Entrepreneurship,
POWERHOMEBIZ.COM, http://www.powerhomebiz.com/vol100/lifestyle.htm (last visited Oct. 5,
2007).
6
See generally Glover, supra note 4, at 168.
7
Martin Wolk, Small Business Having Big Impact on Jobs, MSNBC, Feb. 3, 2004,
http://www.msnbc.msn.com/id/4142727 (last visited Nov. 8, 2007).
8
See
Private
Sector
Funding,
U.S.
Dept
of
Energy,
http://www.eere.energy.gov/inventions/energytechnet/funding/private_sector.html (last visited
Oct. 4, 2007).
9
See generally NERMIEN AL-ALI , COMPREHENSIVE INTELLECTUAL CAPITAL
MANAGEMENT:
STEP-BY-STEP
19-20
(2003),
available
at
http://books.google.com/books?id=15wveJpXMeUC&pg=PA19&lpg=PA19&dq=startups+an
d+%22intellectual+capital%22&source=web&ots=Iqdkpn53xE&sig=Nqs6O1_yLNd90Po2N
EQHiNf0HOc#PPA20,M1.
10
See generally VENTURE IMPACT: THE ECONOMIC IMPORTANCE OF VENTURE CAPITAL
BACKED COMPANIES TO THE U.S. ECONOMY, NATIONAL VENTURE CAPITAL ASSOCIATION
(2007), available at http://www.nvca.org/pdf/NVCA_VentureCapital07-2nd.pdf.
Cherniak & Horton-Panzica—Venture Capital in Promoting Entrepreneurship
193
business? A few more hands. Keep those up for a minute. How many of you
ever got your money out? How many got a lot more than their money out?
The formal venture capital industry – that’s what we are going to be
focusing on more than the informal venture capital industry – is generally
traced back, as you heard yesterday from David Morgenthaler, to just after
World War II.11 Most people trace it back to American Research and
Development. ARD was the first non-family venture capital business, and it
was started up, as you heard yesterday, by a number of businessmen,
academics and university administrators in Boston in 1946.12 ARD invested
in businesses that sought to exploit military technology for commercial
purposes.13
This is a good topic for another session: there is nothing like a war or the
threat of a war to spark technological innovation and, therefore, economic
growth. But that’s really, as I said, a talk for another time.
We won’t go there today, but I want to talk about ARD just a little bit
because it illustrates a number of things about venture capital. ARD’s
approach to venture capital is classic. It invested only in equity and invested
for the long-term; it was prepared to live with losses and negative cash flow
for the short-term.14 Almost half of ARD’s success came from one single
investment: just under $70,000 invested in a company called Digital
Equipment Corporation in 1957, grew to $355 million in 1972 when ARD
was sold to Textron.15 That’s not a bad rate of return. That’s about 500
times.16 You can compare that to the big news in the last few months when
Google bought You Tube for $1.7 billion.17
A number of venture capitalists backed You Tube, including Sequoia
Capital, and I saw on one website that Sequoia Capital put in about $11.5
million and was estimated to get back $495 million on that investment.18
That was considered a huge home run. That’s around 35 times return
compared to ARD’s return. ARD’s total return from 1946 to 1972, before it
11
See generally Glenn Rifkin, A Generation Gap in Venture Capital, THE NEW YORK
TIMES, May 25, 1995, available at http://query.nytimes.com/gst/fullpage.html?res=
990CEED9153DF936A15756C0A96395826.
12
See David H. Hsu & Martin Kenney, Organizing Venture Capital: The Rise and Demise
of American Research & Development Corporation 1946-1973 (Univ. of California-Berkley,
Working Paper No. 163, 2004) available at http://repositories.cdlib.org/cgi/viewcontent.cgi?
article=1128&context=brie.
13
See generally id.
14
See generally id.
15
Id.
16
See generally id.
17
See Google buys YouTube for $1.65bn, BBC NEWS, Oct. 10, 2006,
http://news.bbc.co.uk/2/hi/business/6034577.stm (last visited Nov. 8, 2007).
18
Blogosphere probes ‘GooTube’ deal, BBC NEWS, Oct. 10, 2006,
http://news.bbc.co.uk/2/hi/technology/6036691.stm (last visited Nov. 8, 2007).
115
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[Vol. 33 No. 1]
was sold to Textron, was a 14.7 percent compounded rate of return; without
Digital Equipment Corporation, the return would have been only 7.4
percent.19
What this session discusses is the importance of venture capital in
promoting entrepreneurship, and like all good venture capitalists, the two
individuals on the panel think outside the box. So we are going to run our
panel differently from all the other panels that have run so far, and hopefully,
it will be a success.
It is going to be innovative and will run like a dialogue. Brad Cherniak
and Cathy Panzica will carry on a conversation about a series of topics and I
will put up this series here. They will talk a little bit, but we would like to get
as much audience participation all the way through the panel as possible.
And so I hope that the people carrying the mikes will be nimble for this.
Even though it says Q & A at the end, we would like to have Q & A all the
way through.
Cathy Horton-Panzica has degrees from the University of Michigan, Ohio
State College of Law, and the University of Kent’s Canterbury Theological
College. Cathy is an ordained Episcopal priest, and as you might expect, she
brings both passion and compassion to venture capital investments. Cathy is
the founder and leader of Red Room Revolution, a set of 20 economic
development initiatives in the North Ohio region. She is the founder of Beta
Strategy Group and Beta Opportunity Partners, a fund that intends to fund 24
companies in 18 to 36 months. To date, she has funded six companies and
founded three companies herself. She envisioned and started the Beta
Technology Park in Mayfield Village, Ohio, which transformed a decaying
Industrial Park into a tech park for businesses that use a shared services
platform to reduce overhead. One of her latest ventures is a children's
workshop, which educates elementary school students in a creative play
using technology. And when she is not doing these things, you may find her
leading services as an associate priest at Trinity Cathedral here in Cleveland.
I think she brings a new spin to the term “angel capital.”
Brad Cherniak is not a member of the clergy, so I am not quite sure why
we invited him. I think he may be here more to play devil's advocate. Brad
graduated Summa Cum Laude from the University of Chicago's Graduate
School of Business, which for those of you who know the Chicago GSB,
they probably think they have their own theology. He is a co-founder and
partner of Sapient Capital Partners, a Toronto-based firm that advises midmarket and early stage companies in areas of growth and economic strategy,
acquisitions and divestitures and the sourcing of capital. Brad has 20 years of
experience in investment research, corporate and investment banking,
19
See generally Hsu & Kenney, supra note 12.
195
merchant banking, and private equity and venture capital, with firms like
CIBC, Bank of America, Chemical Bank, and even First Ontario Fund,
which is not noted in his bio, but is a labor-sponsored venture capital fund in
Canada. So I think he is in a good place to comment on the pros and cons of
that model of Government intervention. Brad specializes in small cap private
and early stage companies both as an advisor and principal. He has served on
a number of boards of directors and advisory boards for these companies.
Without any further ado, because I know Henry is getting a little
impatient, I am going to turn to Brad to start the discussion on the first
subject, the relationship of venture capitalists and entrepreneurs: the good,
the bad and the ugly.
CANADIAN SPEAKER
Brad D. Cherniak*
&
Cathy Horton-Panzica*
MR. CHERNIAK: Let me start by saying that when I heard about this
topic, I was actually quite excited to come here, because it is a topic quite
near and dear to my heart. When I started in my field, my first deal was $366
million, and my last deal in March was $5 million . . . so either my career is
in inexorable decline or I made the strategic decision, which I like to think I
have, to focus on entrepreneurs and their companies – because I think it is a
very challenging and rewarding world, and it is a great place to spend a
career.
But I thought what we would do is discuss – first, can you hear me okay
in the back? Is my voice carrying? Okay. We thought we would delve into
the relationship between VCs and entrepreneurs . . . and that we might as
well start with the dirt!
You know, if you are going to discuss a relationship, you want to start
with the bad side rather than the good side. So I’m here to give you the
straight goods – but, this being said, I have to say I feel a little bit duped and
misled by Daniel and by this Institute, because I was brought here to sort of
tell you the straight goods on deals and VCs and what really goes on in the
trenches . . . but I find out I am sitting next to a reverend, and my every word
116
196
[Vol. 33 No. 1]
is being recorded by every media imaginable. So under advice of my
counsel, I would like to conclude my remarks for today . . .
So the first section really discusses what each side doesn’t like about the
other. And to start with the VC as the first target, what are the beefs on
venture capitalists? The first one, increasingly so, is “why are their term
sheets so aggressive?20 Why are deals getting scarier and scarier, getting
more complex?”
Frankly, it is the nature of the beast. It is a negotiation, with a lot at stake
economically and otherwise.21 So you are always looking for the upper hand,
*
Brad Cherniak is Co-Founder and Partner of Sapient Capital Partners, a Toronto-based
firm which advises mid-market and early stage companies in the areas of growth and corporate
strategy, acquisitions and divestitures, and the sourcing of capital. Mr. Cherniak has close to
20 years of experience in investment research, corporate and investment banking, and
merchant banking and private equity venture capital with such firms as CIBC Wood Gundy,
Gordon Capital, Bank of America and Chemical Bank. Mr. Cherniak graduated Summa Cum
Laude from the University of Chicago’s Graduate School of Business.
*
After being educated in High School by the Quakers at George School in Philadelphia,
Cathy went on to graduate from the University of Michigan in 1983, The Ohio State College
of Law in 1986 and The University of Kent Canterbury Theological College in England in
1999. In 2000, she was ordained as an Episcopal priest. Cathy has spent over 20 years
cultivating a global mergers & acquisitions and venture finance legal practice, serving a
myriad of clients that range from the Fortune 100 companies to emerging and mid-market
enterprises. She spent 15 years in London, where she developed a passion for technology in
the emerging companies’ market place. In Europe, she formed her own consulting practice and
worked with global enterprises and start-ups to foster and capture the value of strategic
technology innovation. Cathy has dedicated herself to transforming economies through the
creation of truly innovative business strategies using technology. While in London, Cathy
served as a trusted advisor to the Cabinet Office of the Prime Minister, Tony Blair, to help
generate ways in which technology development could drive economic outcomes for Britain.
After her years in London, Cathy recently returned to her native United States to continue her
practice of law and consult with technology driven enterprises. Cathy is the founder and leader
of the Red Room Revolution, a set of 20 economic development initiatives structured to
transform the Northeast Ohio Region using a technology platform. She also is a founder of the
Beta Strategy Group and Beta Opportunity Partners Fund which has made a commitment to
fund 24 technology companies in 18-36 months. To date, Cathy has funded 6 companies and
founded 3 of her own. She also envisioned and started the Beta Technology Park in Mayfield
Village, Ohio which transformed a decaying industrial park into a tech home for early stage
companies to grow using a shared services platform to lower overheads. She has recently
renovated an old barn to headquarter her new business, Children’s Technology Workshop,
which educates second to eighth graders in creative play using technology. Finally, Cathy is an
Associate Priest at Trinity Cathedral in Cleveland, Ohio.
20
See, e.g., Joseph L. Lemon, Venture Capitalism After the Burst of the Internet Bubble:
Selecting Financing Terms with Care, 2 MINN. J. BUS. L. & ENTREPRENEURSHIP 1, 5-6 (2003),
available at http://www.centerforbusinesslaw.org/journal/v2n1/lemon.pdf (discussing
aggressive term sheets).
21
See generally Vivek Wadhwa, Before You Accept VC Funding…A Veteran Entrepreneur
Tells You What You Need to Look For in a Venture-Capital Firm Before You Agree to a Deal,
BUS. WK. (August 3, 2006), http://www.businessweek.com/smallbiz/content/aug2006/
197
and you are trying to get the best valuation possible, the best terms
possible.22
It is also a natural, broad trend in business – as companies become more
efficient, shareholders increase their expectations, all given a turbo boost by
hedge funds and other activist shareholders, every side of every corporate
relationship attempts to squeeze every last dime of value from their
counterparties. You are forced in a sense to get more creative over time, to
get more and more aggressive and scary going in.
I also think the lawyers should take their share of the blame! I have had
some very creative counsels that thrilled me over the years as a venture
capital fund manager, in giving me scary new implements with which to beat
the entrepreneur over the head if necessary! So lawyers have to take their
share of the blame!
All this being said, I think there is an interesting and even counterintuitive sea change happening in the market. There is an interesting new
trend towards simplicity and trust, and it is kind of driven by the
developments I just described above. I can speak to that very well from my
own experience – it is also driven by simple practical reality in such cases
where you have companies where the venture capital funds are putting in
multiple rounds of capital, possibly with new investors coming in on some of
these different rounds. I have had these types of situations where the paper
trail of documents and terms and rights and obligations becomes so
complicated and convoluted and overlapping and conflicting that, despite
having all these nuclear weapons, there is essentially no way to detonate
them before you can get your own butt out of the room!
So what you have to do in this instance is frankly start with a blank sheet
of paper and say, okay, all of us clever professionals have kind of painted
ourselves into a strategic and intellectual corner here. We can’t make
decisions because we’ve got five different shareholders agreements – each
more complex than the last – it becomes hard to say who trumps whom. So
let’s call it a draw and re-cut the pie. One can look at this situation and
wonder what all the legal expense and effort was for. Simplicity is becoming
more practical. It is becoming a practical thing as well as a trust-driven thing.
MS. HORTON-PANZICA: I find it interesting to blame the lawyers
because during yesterday, making a list of the terms that pervade our space,
and they come from lawyers: preference, drag, tag, ratchet, hatchet,
laddering, pump and dump, underpricing, crowdouts, control, forced exit,
rushed exit, later-stage blinders, piggyback, grand standing, flips.
MR. CHERNIAK: I have done every one of those . . . some twice!
sb20060802_804397.htm.
22
See generally id.
117
198
[Vol. 33 No. 1]
MS. HORTON-PANZICA: If anybody doesn’t know what any of that
means, it is the dirty language that pervades what we are doing. And when
we started talking about this session, I said, you know, why don’t we talk
about what we need to do as responsible professionals to change this?
I like to say that the trend that I have been trying to work with the
investments that my group is doing, and in partnership with other people, is
to simplify due diligence, so you don’t have entrepreneurs who should be
running their businesses and inventing and being creative fund people. They
are spending nine months in due diligence for a million dollars that is not
even spent, and having them review 15 drafts of 45 term sheets for the 45
people who are investing, and completely send them down side roads when
they need to be straight ahead.
The investments that we have been doing – we don’t even present the
term sheet until all of the investors in the consortium agree. There is one term
sheet that the entrepreneur is reviewing for everyone.
We also have a fixed due diligence program where we only do due
diligence upfront on the things we really, really care about. So we are
changing – actually, there are a few things we really, really care about – the
intellectual property and how quickly are we going to cash flow based on the
numbers we think are there.
Once we know when we are going to cash flow and whether the IP is
commerciable outside of the opportunity, then we have done a lot of the derisking already. We will not have to spend nine months in due diligence. We
don’t have to get into 45 term sheets, and we don’t have to get into ratchets
and hatchets and preference. None of that stuff is really what’s on the table;
we have taken all that off.
So I sort of wanted to say, in this trend about where we are going in the
common beefs, is why don’t we as professionals try to get rid of some of this
mystification of deals and the way that we treat one another and start
simplifying things for the entrepreneur.
MR. CHERNIAK: Just on the second point, this is a question I get asked
a lot by entrepreneurs, and part of it is just the nature of the business. You
know, the entrepreneurs, they know they need capital, but frankly, they are
not happy about needing it.23 And some of them actually don’t know they
need it; they just know that they need something.24
Again it is the nature of the business. You are coming in, and you are
taking a chunk of an entrepreneur’s baby, their dream. So it is kind of a
negative starting point almost in nature. I think, as well as the nature of the
23
See, e.g., Giacinta Cestone, Venture Capital Meets Contract Theory: Risky Claims or
Formal
Control?
3
(2001),
available
at
http://www.recercat.net/bitstream/2072/1967/1/48001.pdf.
24
Cf. Id.
199
business in venture capital, that the women and men in the venture capital
business living with this are spread very thin, partly by design.25
One has to wonder why the venture capital funds couldn’t add more VCs
per dollar invested, just so they could spend a little more time, be a little less
abrupt in their dealings with people – but at the end of the day, as a VC you
really are forced to run from deal to deal, crisis to crisis, opportunity to
opportunity, which kind of creates the incentive to be somewhat abrupt and
very efficient with your time, so to speak.
I think success also does breed overconfidence in the industry. There
certainly is an arrogance wafting through the industry. It is a dog-eat-dog
industry, with little love lost between venture capitalists, each seeking to win
their way through, compete against other venture capitalists, and get their
money into the marquee companies.
You have got to be a sharp-elbowed tough man or woman to do it. The
more and more successes you have as a fund, the more the VC becomes a
caricature of what they were in the business to begin with--personality quirks
get more and more pronounced, since there is no one to set them straight.
You, as the VC, end up failing to recognize your own limitations, and you
get into an operational groove in terms of the way your fund does business.
You will slam a square peg into a round hole because you are a very
successful square peg!
Funds tend to try to replicate their successes by doing what they did well
in the past, like a pitcher with a good slider and not much else they are very
confident in. Your fund may be particularly adept at some particular function
like finding new sales channels for software companies or merging
investments together or adding aggressive, operationally focused executives
in their Rolodex to accelerate the pace of companies getting to the next level.
You tend to go sort of back to the things that you are good at, and sometimes
again it turns you again into pounding square pegs into round holes, whether
your action is optimal or even needed at that moment, or whether the CEO
recognizes the need or agrees, that’s what you do anyway – turn your
companies into the same sort of animal.
And then I think the last point is fairly commonly felt by entrepreneurs – I
certainly have seen it. VCs can certainly lack a bit of respect for the effort
and skill it has taken to create what has been built to date. This is a difficult
and complex issue, and not easily summed up or solved.
MS. HORTON-PANZICA: Among the most frequent complaints that I
have heard from entrepreneurs who are accepting venture money is that they
end up feeling completely devalued in the process.26 They are in a situation
25
See generally Lorin Cohen, Writing your Business Plan, BIOENTREPRENEUR 1 (2002),
http://www.nature.com/bioent/building/planning/012003/pf/nbt0602supp-BE33_pf.html.
26
See, e.g., Ralf Becker & Thomas F. Hellman, The Genesis of Venture Capital: Lessons
118
200
[Vol. 33 No. 1]
in which they created a seed of wealth for everybody, and investors lose sight
of that.27
They created the seed of wealth from which the venture capitalists are
going to make these astounding returns, we hope. And somehow in the
process of the arrogance of having the money, we forget about the value of
the person’s creations. And so we set up an aggressive and some sense of
animosity between the venture players and the person that has created them.28
And I like to think that what we certainly are trying to build into our
environment is a different sense of conscience about how we treat
entrepreneurs. Entrepreneurs are creative.29 They are out of the box and they
have this sense of creativity, and when you try and stamp it down and press it
in and put it in a box and limit it, you have killed it. Until you get the venture
capitalist with the right appreciation for that mind set – again back towards
that mind set – and appreciating it and valuing it, I think we are trying to
inject the wrong kind of personality next to the relationship of the
entrepreneur.
DR. KING: Have you had any bad experiences with your new approach,
which I think is a good one?
MS. HORTON-PANZICA: I haven’t yet. The one situation, which I got
back into a good resolution, was that I met a young chap from New York. He
was talking about his company in a session that I was in, and I went up to
him, and I said, “I am going to invest in you, and I like you. I like who you
are, and I am going to let you run with what I see.” And I did that, and he
was bought six months later by a public company. And that was a good
thing.
But as he was exiting, I had a right to take some additional warrants, and I
gave that up because the investment was so short because I didn’t feel good
about taking them. I know that sounds really strange, but I actually didn’t
feel good about it. I made a huge return.
I gave up warrants, and he had to transfer money to my group, but he
didn’t pay it for about 90 days. I told him, “You know, I trusted you. I dealt
with you with a certain ethic, and you are violating it.” Once I sent that email to this chap, we had the money wired within 24 hours.
from the German Experience, CESifo Conference Centre 12-16 (Nov. 22-23, 2002)
http://www.cesifo-group.de/portal/page/portal/ifoContent/N/neucesifo/CONFERENCES/
SC_CONF_1999-2006/VCE02/PAPERS/VCE02-HELLMANN.PDF (unpublished research
paper used in CESifo Conference in Munich).
27
Id. at 14.
28
Id. at 12-13.
29
Debora Markley & Don Mackey, Community Environment for Entrepreneurship,
FOR
RURAL
ENTREPRENEURSHIP,
June
2003,
at
2,
CENTER
http://www.ruraleship.org/content/content/pdf/Community.pdf.
201
If you are going to work that way, you have to demand it in return, right,
because it is not the environment. But it worked, but you have to keep it real.
I am much happier operating that way. I don’t want to be in this drag tag
ratchet and hatchet. I am not interested.
MR. CHERNIAK: That’s actually a good segue to this point, which is, do
deal terms actually limit relationships between investors and entrepreneurs?30
And I think the answer is actually yes. Although I hate to admit, I have done
the same thing in terms of not exercising the rights that I legally have in my
agreements. At the end of the day, you want to make sure you don’t poison
the relationship with your entrepreneur, to be penny-wise and pound-foolish.
Although you may be entitled to it under your agreements, if you strip the
entrepreneur of too much of their equity and upside, either for
underperformance or additional unforeseen capital requirements, the
relationship and possibly the investment is eventually going to break down.
The entrepreneur is going to lose interest and motivation. They are going to
either break down or leave! By the end of the day, you start to wonder
whether having all those rights are actually necessary.
Again, although I have to admit that looking forward in negotiating future
deals I would probably still try to get these weapons. It would be hard to give
them up, but I am not sure I would use them. And I think one of the key
points in this discussion is that the personal relationship between the VC and
the entrepreneur, the chemistry is absolutely paramount in successful
investing.
You may have a big institutional fund name; you may have a high-profile,
sexy company name with big dollars involved. However, at the end of the
day, it is two people, and if it doesn’t work, if they don’t trust each other or
they don’t take each other’s advice, if they don’t listen, the relationship is
screwed.
You are not going to be successful, no matter how good your technology
is, how good or smart the entrepreneur is, or how smart the VC is. In my
mind, it is the most critical aspect of venture capital and the linchpin of
success, but it is also the least scientific and the toughest thing to nail. That is
why, as I moved over to the advisory side of the relationship between these
two animals, it was really to figure out the best way to make sure that match
is there, and you are not just taking the best money at the best terms. You are
putting together the women and men who fit best with that entrepreneur.
30
Cf. TONY BERRY, DAVID LEE, JIA MIAO & ROBERT SWEETING, ACCOUNTING AND
ACCOUNTABILITY IN A VENTURE CAPITAL FUNDING PROCESS 2, available at
http://72.14.205.104/search?q=cache:hvsPNciy08YJ:www.licom.pt/eaa2007/papers/EAA2007
_0325_final.pdf+ACCOUNTING+AND+ACCOUNTABILITY+IN+A+VENTURE+CAPIT
AL+FUNDING+PROCESS+%22tony+berry%22&hl=en&ct=clnk&cd=1
(Investeeentrepreneur relationships are similar to that of principal-agent relationships, where
information asymmetry leads to agents limiting effort).
119
202
[Vol. 33 No. 1]
You know, with most of my clients I spent more time than I almost cared
to in the trenches, really seeing how they function, how they think, what
drives them, what scares the hell out of them, and what changes their
behavior. And similarly dealing with a bunch of VCs, as either colleagues or
competitors or friends, you see what their hot buttons are; the match is the
critical thing.
I think “overly-nasty” agreements tend to keep the two at arms length.
The CEO tends to go into a shell, probably for good reason! You know, they
are scared to death of losing their company. So maintaining that chemistry is
key to a good relationship, in my mind.
MS. HORTON-PANZICA: I think a lot of the relationships get off on the
wrong foot because we don’t have the money right. So many times I have
young entrepreneurs come into our group, and they are either asking for too
much money, too little money, or they don’t need money when they are
asking for it. So they are asking for an engagement with the venture world,
when they don’t have the quality and quantity of what they actually need to
finance.31
You automatically set up a situation where a venture capitalist is going to
give too much money to an entity and want a deeper return, not enough
money and risk wanting a deeper return, or putting money in when they don’t
really need it and getting a better return, right?32 So we are setting up the
wrong chemistry.
So I think part of a professional’s job and part of the venture capitalist’s
job is to stop that process and sit down with the entrepreneur and say,
actually, do you have this quite right? I had a wonderful client from San
Francisco, and she had great technology. I would invest tomorrow, but she
doesn’t need me now. I sent her home and said you don’t want my money
right now. Keep pressing with friends and family right now.
You are all right like this, and you are going to make it. Come back, and
we will raise you around, but you don’t need it right now. That was the right
thing to say. I think that if you create that sense of trust by taking a look at
the mechanics of the money and when it is needed, that’s a much better
relationship.
The other comment I had here is that rather than looking at the terms that
I just read off to you in a basket of rights for the venture money, I like to say
to the entrepreneur, this is our environment. I invite you to play in it with us,
and if you achieve these three or four or five milestones, if you do this and
you are exceptional, you will have rights and money and extra value coming
back to you.
31
See, e.g., Rob Holland, Planning Against a Business Failure, AGRIC. DEV. CTR – U.
TENN., ADC INFO #24 , at 3 (1998) available at http://cpa.utk.edu/pdffiles/adc24.pdf.
32
Id.
203
It is called in our business a clawback.33 Do I give you a clawback of
some of what you have given to me because you truly are exceptional and
you can prove it? Then you have given a modicum of respect to this
entrepreneur.
It is a different field than all these rights on their own in favor of the
venture capitalist.
MR. McCREARY: Cathy, why do you call it a clawback and not an
incentive?
MS. HORTON-PANZICA: That’s a good point. You are saying you have
a right to actually bring it back. The language should change. It is not really
an incentive; it is a right to earn back what they had to give up in order to get
the equity.34
MR. McCREARY: My follow-up question is whether most of the terms
can be turned into positives rather than subtractions and negatives?
MS. HORTON-PANZICA: Absolutely.
MR. McCREARY: And if you get that environment, isn’t that what
happens in the ones that have been winners for you? Have you ever seen it
not be the case where the relationship was very positive?
MS. HORTON-PANZICA: Absolutely.
MR. McCREARY: And once there are failures, you are always a failure.
MS. HORTON-PANZICA: There are negatives, and the industry calls it a
clawback. I mean, we use these terms. We throw them out; it is aggressive.
The ones that stay when the chemical reaction is right, it is just on fire. It
really creates an exciting, positive relationship.
I am going to Toronto next Sunday to go see these entrepreneurs in
Toronto. I am counting the days since I am so excited.
So that’s the kind of chemistry you want from the person putting money
behind you, and I think when that changes, it is like any relationship, right?
Once you interject negative comment or aggression into any relationship in
your life, it is the same way, right?35 So what’s your conscience – why is
your conscience any different when you invest in money? Is it money that
makes us gorillas and ugly? I guess.
33
DAVID L. SCOTT, WALL STREET WORDS: AN A TO Z GUIDE TO INVESTMENT TERMS FOR
TODAY’S
INVESTOR
(Houghton
Mifflin
Company
2003)
available
at
http://dictionary.reference.com/browse/clawback (clawback is defined as “[e]xcessive
management share of profits that must be refunded to investors of a venture capital fund. A
clawback is required when managers of a venture capital fund take a contractual share of early
investment gains that are subsequently reduced by losses”).
34
Id.
35
See e.g., Geraldine Downey & Scott I. Feldman, Implications of Rejection Sensitivity for
Intimate Relationships, 70 J. PERSONALITY & SOC. PSYCHOL. 1327, 1329 (1996), available at
http://www.columbia.edu/cu/psychology/socialrelations/downloads/rspersonal.pdf.
120
204
[Vol. 33 No. 1]
MR. McCREARY: No. I think it is a question of people not meshing well,
and the chemical relationship between the venture capital and the
entrepreneur is as important as the money relationship.36
MS. HORTON-PANZICA: Well, in our relationships with the people in
our lives, we don’t have all these ratchets and hatchets and claws and all that
stuff going on, do we? We don’t talk about it.
I guess what I am saying, why don’t we create an environment where we
don’t have that language exist, and you change it, which is the point you are
also making, so that those relationships are supportive and ones that induce
success rather than failure.
MR. CHERNIAK: There are different nomenclatures for clawbacks. In
my last deal, it was called an “earnback.” I have also seen it referred to as a
“reverse option,” among other things. I have seen a whole bunch of different
names, but for me, actually, I find as long as you are negotiating “straight
up” with the entrepreneur, it doesn’t matter. For example, one term that is in
a lot of term sheets that I never accepted and never will is “investment
multiplier,” which kicks in when you sell a company.37
As an example, the venture capital fund puts $5 million into a company.
Under this term, the fund must receive or “earnback” $15 million before the
entrepreneur and other existing stakeholders get anything. I have always
found that to be a backdoor way of negotiating more equity, sometimes
without the entrepreneur even understanding the real economic meaning of
the term. It is becoming less common these days, although it was very
common in the venture capital boom times around 1999 and 2000.38
I find when you take out terms like that, that scare the entrepreneur into
thinking, “I really need to understand how this REALLY works,” if the
agreement is more straightforward, you can still keep some aggressive terms
in there.39
36
See, e.g., Olav Sorenson & Toby E. Stuart, Syndication Networks and the Spatial
Distribution of Venture Capital Investments, 106 AM. J. OF SOC. 1546, 1549-1551 (2001),
available at http://leeds-faculty.colorado.edu/bhagat/syndicationnetworksvc-investments.pdf
(“Professional relationships provide one of the primary vehicles for accessing timely and
reliable information about promising new ventures”)
37
JOHN MAYNARD KEYNES, THE GENERAL THEORY OF EMPLOYMENT, INTEREST AND
MONEY 82 (Elizabeth Johnson ed., Harcourt, Inc. 1964) (1953) available at
http://www.unilibrary.com/books/Keynes,%20John%20Maynard%20%20The%20General%20Theory%20of%20Employment,%20Interest%20and%20Money.pdf.
38
Cf. Thomas Hellmann & Manju Puri, The Interaction Between Product Market and
Financing Strategy: The Role of Venture Capital, 13 (4) THE REV. OF FIN. STUD. 959, 980-981
(2000) available at http://strategy.sauder.ubc.ca/hellmann/pdfs/RFSofficial.pdf (stating that
the number of firms looking to use venture capital is increasing, thus type and terms of
investment are more likely to favor entrepreneurs, which controls development path of
companies).
39
See, e.g., Lemon, supra note 20, at 6, 7.
205
If it is a clawback, it is a clawback. As long as it is straightforward, you
hope the chemistry of that relationship is solid. It is the kind of stuff that
really springs on you later, which the entrepreneur doesn’t really understand
the effects of it until it hits them in the head or their lawyer informs the what
this thing really going to do to them that kills the chemistry and possibly the
investment ultimately!
MR. McCREARY: Of course, no guarantee.
MR. CHERNIAK: Oh, you have those, too. But it is when you, as the
entrepreneur, are surprised by terms that that were not really highlighted or
fully explained in the negotiation, I find that poisons the relationship.
MR. SANDLER: Let’s turn to the good, Brad.
MS. HORTON-PANZICA: That’s actually a very worthwhile point, part
of what poisons the relationship with the venture capitalist. One of my very
dear friends who started a business – very successful, invested in by large
houses in New York – he is going to leave in the next two or three months
with five percent of this company, and he is so bitter.40
And the reason why he is going to do that is because he took on equity too
soon, and he took on too much, and he didn’t need it all, and he gave away
the bank, literally. And so, you know, being penny-wise and kind of poundfoolish, giving up equity, he came to me, and he wants to do another
company.41
He said, “I don’t want any venture money at all. I don’t want to see it
again.” This is a guy that is going to start three or four or five companies
before he is finished with his career. Probably until he is gone he will be
starting new companies, and this is his attitude now. That’s sad.
That’s why I think the negotiation of the amount of money we actually
advise entrepreneurs to pay – and they even have a drawdown. I have done
that. I had one deal where I had given him a drawdown and to take what they
need, and I get a little richer because the money is drawn, because then they
need more from me.
And I have more money at risk, but giving them a drawdown to take what
they need as they need it in case things go wrong, that’s a very civilized way
of financing something.
MR. CHERNIAK: The flipside to that, both of these, to me, are such
critical points in terms of how deals get done and whether deals end up being
good or bad. To play the devil’s advocate for a second – I like doing that.
40
See generally Malcolm Baker & Paul A. Gompers, Executive Ownership and Control in
Newly Public Firms: The Role of Venture Capitalists (November 1999) (unpublished thesis,
on
file
with
the
Harvard
Business
School),
at
3,
available
at
http://www.people.hbs.edu/mbaker/cv/papers/Ownership.pdf.
41
See generally Douglas G. Baird & Edward R. Morrison, Serial Entrepreneurs and Small
Business Bankruptcies, 105 COLUM. L. REV. 2310, 2329, available at
http://www.columbialawreview.org/pdf/Baird-Morrison(Web).pdf.
121
206
[Vol. 33 No. 1]
MS. HORTON-PANZICA: Where is your fork?
MR. CHERNIAK: I think it was in the soup last night!
I recently put a deal on ice for an entrepreneur who was too much the
other way, too equity-stingy – he could not accept the idea of taking any
dilution at all, and, in fact, turned down money that was critically needed for
his company. He is at the point where he is growing, but doesn’t have a full
appreciation of the effect of growth on cash flow. This is actually where most
entrepreneurs kind of run off the rails, is not understanding that your business
is booming, but it is not going to generate cash flow as quickly as it generates
profit. Indeed, it will continue to consume cash in the form of working
capital to sustain the growth.
So you need a balance sheet to grow your company. I have spent a lot of
time on that topic with entrepreneurs, and with this one in particular, I just
could not get the point across.42 And frankly, he could lose his business
because of it, for sort of the opposite reason, and that again is being too
stingy on giving up equity.43
There is a balance between the two, not taking too much, not taking too
little and the problem extends in both directions.44
But let’s get to the good stuff! Bottom line, the situation is not so bad.
Actually, overall, the relationship is working, and we will talk a little bit
about the macro numbers.
But when it does work, I think you will agree it can be a fantastic
relationship. VCs can and do fill in the gaps (or weaknesses or blind spots)
that all entrepreneurs have to some extent. When they recognize they have
these gaps, the relationship can work very well. As an example, a gap could
be, you know, being a great operator but not being very good at managing
people; or being visionaries in their businesses but not understanding really
how to put a business together and make it work and earn sort of the money
they need to make their investors happy. So the VCs can be perfect to just to
fill in those gaps or blind spots.
Another critical aspect of the VC/entrepreneur relationship is in guiding
the entrepreneur to pick the low hanging fruit – the basic elements of what
makes a business successful, and sustainable. This blocking and tackling is
something every company has to do. If you have been in the corporate
finance/venture capital industry for as long as I have been, these points
become second nature, but you realize they aren’t necessarily as clear to an
entrepreneur. You must keep them focused, hew to a flexible, proactive, and
reactive strategic plan and use all the resources in the company to their
42
43
44
See, e.g., Lemon, supra note 20, at 8.
Id.
Id.
207
maximum. This can be, conceptually, fairly simple, but actually much harder
said than done.
I think if entrepreneurs have a weakness: sometimes they don’t know
when to stop.45 I had one, with a very successful, growing early stage
enterprise, a software company for which we executed a financing for very
recently. He is just at the cusp of breaking into the U.S. market – big
enterprise customers.
His average unit sale going forward will likely be in excess of his total
cumulative historical sales, and he will now be dealing with giants such as
Boeing and Microsoft and Wal-Mart and those types. That’s all fine and nice.
You stretch to the max to meet their high expectations and short tempers. He
is just barely keeping it together, and he gets a visit from a group of
entrepreneurs from Dubai who are setting up sort of a venture capital
incubator in the Middle East. Intriguing, but probably ten years away from
fruition, and it is going to take a lot of work and a lot of pain, attention and
travel – and money. They come to him saying, you know, we would like to
incorporate your technology into our concept. All you need to do is provide
us with technical and managerial and some executive expertise and some
money.
So he brings me in and says, “This looks interesting.” My reaction, if you
edit out the expletives, was to say nothing! Again, the entrepreneur’s creative
engine just doesn’t have brakes or, perhaps, a steering wheel. The insights of
a VC were critical here to avoid a costly and potentially fatal dalliance
caused by well-intentioned naivety coupled with endless energy and
enthusiasm! The system worked here.
The Company ended up walking away from that opportunity because it
was the prudent thing to do, and I think that’s what a VC has to do, or an
advisor in this case – to focus his efforts and make sure he is focused on his
core business, which in this case is enterprise software business – moving
from Canada to the U.S. I just don’t know why he thought he had all this free
time and bandwidth to spend in Dubai, but what are you going to do?
MS. HORTON-PANZICA: Before you go on to the governance piece, it
would be interesting – I don’t know how many companies you invested in
your group – which you would say the entrepreneurs are? Good CEOs? And
one of these CEOs, and I was sitting in the back trying to think about that
before I spoke, and I am under 50 percent, and therefore, you got a massive
blind spot because the point is the entrepreneur wants to be the CEO.
45
Cf. Morey Stettner, CEO Peer Support Can Power a Firm’s Business Growth,
INVESTOR’S BUS. DAILY, Mar. 5, 2007, at A11 (Entrepreneur dissuaded from expanding
business in favor on focusing on existing firm).
122
208
[Vol. 33 No. 1]
MR. COHEN: I have a question in regards to your initial comment and a
most recent comment. That pertains to one of the most important things you
look at, and you stated you look at the IP and the cash flow.46
MS. HORTON-PANZICA: And the people.
MR. COHEN: That’s the key.
MS. HORTON-PANZICA: And the people. I don’t even get there until I
like the people.
MR. COHEN: Many instances you recognize immediately that the
entrepreneur doesn’t have the management skill to take it further. And how
often do you tell them that before you fund it, that you are going to have to
bring in outside management? Do you tell them that initially? Do you wait?
What’s your process?
MS. HORTON-PANZICA: I don’t even get to the IP and cash flow until I
see the person is somebody that just excites me with the spark that they have
and the drive and the ambition and the foresight for whatever market they are
in to be able to drive and drive hard. Otherwise, I am not interested if I don’t
have that upfront.
I would say I am very honest. I say, “this is what you are good at, and
what we need to do is get you this set of management skills. That’s
something we will do; we will even do it for you until we find the right
person.” I have done that.
I am doing that right now in a company that I invested in. I love their
technology, and they now have been taken in by a large vendor as a software
tool. It has been a great investment. The guys that developed the software, I
told upfront, that they were going to need help. I put someone on the board,
and I have the head of my investment fund actually working alongside these
guys constantly on management issues and getting the right management
team around them. So I say it upfront because if I am putting money in as a
passive investor and see problems, I am actually not interested in that model
because I know it is going to fail.
One time I did that recently where I went alongside other investors and
stood back. Even though I loved the technology, but I had real doubts
whether he could lead and didn’t go with my instincts. It has been, at best,
challenging.
I think you have to instinctively be very upfront and fill that gap if you
are capable. If you managed the P & L and are worried about whether the
employees can pay their mortgages, which I have, then, if you cut your teeth
on that worry, you can drive management help into the VC environment,
where the entrepreneurs never had to worry about that.
46
See generally Steven N. Kaplan & Per Strömberg, How Do Venture Capitalists Choose
Investments? (August 2000) (unpublished thesis, on file with the Graduate School of Business,
University of Chicago), available at http://isc-capital.com/downloads/aic82k.pdf.
209
They had just been inventing, right? And now they are taking on
employees; they are taking on space; they are taking on cost; and where is
the conscience about whether I can pay the bills? Where is my cash flow?
Where is my customer base? How am I going to pay my people?
So if that’s the mindset you have, you have to put the skills out there, and
you have to be the one that sees the blind spot and say, “Here, if you want
my money, then you also want this expertise because if you don’t want this
expertise and us to help you with the management side of this, then don’t
have my money.”
MR. CHERNIAK: We spend a lot of time on transactions of earlier stage
companies and the notion of being very upfront with, usually, a CEO or
founder about what’s likely going to happen after the institutional capital is
in, and whether this scenario will be acceptable to them. What’s the range of
outcomes they are willing to accept in order for the company to be successful
– which could be bringing someone in just under them, such as an
experienced COO, or in some cases it could be bringing in a new CEO above
the founder and putting them into a technology executive role or sales,
second-in-command.
We spend a lot of time with the dynamics of what the team is going to
look like before and after the money comes in.
MS. HORTON-PANZICA: What’s your – you asked a question, what’s
your – do you agree with what I am saying, or do you have a different
approach?
MR. COHEN: No. I agree with what you are saying. I just wonder how
much you do with due diligence, use some tools like physiological testing?
MS. HORTON-PANZICA: Yeah.
MR. COHEN: Have you spent time interviewing the spouse?
MS. HORTON-PANZICA: I have not done that.
MR. COHEN: Because you are right, entrepreneurs are a special breed.
The conflict you get between the institutional venture capitalist and the
entrepreneur very often comes when you intrude on their management, when
you try and put that skill set in.47
MS. HORTON-PANZICA: Yeah, I agree. It is interesting on the spouse
side because I have an investor that is in trouble because the spouse is not
supporting the entrepreneur. And it is very, very disappointing. The
entrepreneur is a 24-7 pizza-under-the-door kind of guy and the spouse isn’t
willing to support such a lifestyle when the business requires it.
MR. COHEN: I will close it out. You don’t want to hear my war story.
47
See, e.g., Thomas Hellmann, The Allocation of Control Rights in Venture Capital
J.
OF
ECON.
57,
59
(1998),
available
at
Contracts,
29
RAND.
http://strategy.sauder.ubc.ca/hellmann/pdfs/ControlRights.pdf.
123
210
[Vol. 33 No. 1]
MS. HORTON-PANZICA: I love your war story, but that’s very
interesting. I wonder how violated one might feel saying I want to interview
your spouse, but I would like to talk about that a bit more.
MR. CHERNIAK: It goes the other way as well in terms of delving into
what the VCs are really like, talking to their investees, talking to their
partners. That’s a process that we spend a lot of time advising our clients to
insist on – that they spend a lot of time with the individual VC that is going
to be there going forward, as their director, their guide, and their institutional
investor. Entrepreneurs should also meet the VC’s partners in social settings,
as well as some of their investees. The good funds are only too happy to
facilitate this. If they are wary, you have something to worry about.
MS. HORTON-PANZICA: You know, when you are advising an
entrepreneur about what type of venture capitalist you want to go to or
should go to, it is very important to look at the track record of the money.48
Those VCs that have great track records of staying in deals, the entrepreneur
ought to be interviewing hugely the venture capitalist.
This should be a beauty contest both ways. How have you succeeded?
What have you done? Let me interview your investments. Let me talk to the
people you dealt with. Let me talk to management of companies because this
is a marriage. It is a broker’s marriage, and if you get the wrong chemistry,
you know the marriage certificate, right?
So, you know, how are we setting up anything that is any different if we
don’t get the chemistry right between the entrepreneur and the VC? You
know, if you have got a young venture firm that has a proven track record,
they are going to grandstand investments. They are going to grandstand
them. They are going to dump them early. They are going to do early exits to
build their portfolios. Do you want to be with a grandstander or do you want
to be with somebody that has got a little bit of experience and stayed in
investments?
And they put money at risk, and they have been a long-term venture
capitalist. They put their money where their mouth is, so it is very important
that when you pair the entrepreneurs with the venture capitalists, it is the
right kind of venture capitalists.49
MR. CHERNIAK: I think we have talked about a lot of these points, but I
think one critical one – and again I think we kind of touched on this – but it
is a horse sense of how to help the entrepreneur build his team. I think, when
I was in the business, in my own mind, I spent half my time on what I call
48
See, e.g., Rafael Amit, James Brander, & Christoph Zott, Why do Venture Capital Firms
Exist? Theory and Canadian Evidence, 12 J. OF BUS. VENTURING 441, 444 (1998), available at
http://strategy.sauder.ubc.ca/brander/papers/Why%20Do%20Venture%20Capital%20Firms%
20Exist%201998.pdf.
49
See, e.g., Sorenson & Stuart, supra note 36, at 9.
211
human resource issues, because one of the biggest areas where a VC can add
value is in helping the entrepreneur avoid making big mistakes in hires.50
Speed them up the learning curve using your own experiences up the same
learning curve.
You may have your team of three people, and you are bringing a sales
executive or some other critical role, at this point the stakes are so high, an
error in judgment could start the chain of events that could be fatal to your
business.51 Early stage companies are all about chemistry and positive
momentum, and are not well positioned to recover from disruptions in these
areas.
So I think one of the most critical things that a VC brings is not only
qualified people to fill that key new role, but the horse sense to figure out
whether the fit is mutually right, whether it is the right company for them,
and whether they are going to stick it out.52
We had one client, a software company based in Montréal, which raided a
high-ranking executive from a big public U.S. company, but without
realizing how much they were going to have to pay to keep this guy happy in
the medium term, in both cash and in common equity of the company – this
person was very excited about the company’s concept and potential, but at
the end of the day, the economics didn’t work – neither side really did their
homework. This is a very costly mistake for companies.
But I guess I need to pick up the pace here. I would like to talk about the
next point for a long time, but why don’t we just go on?
MS. HORTON-PANZICA: I think one thing that I would like to say is, as
professionals, if you find that the entrepreneur or the venture capitalist has
made a bad employment decision, the worst mistake is to try and fix it.53 Get
rid of it. I mean, I think what I have learned, if you try and fix a bad hire or a
bad situation, it only gets worse.54
It is far better for all professionals involved to say we made a bad
decision. Let’s go find the right person as soon as possible. You just fix it.
Trying to nurse something along is detrimental to the younger business that
50
See, e.g., Robin Broadway & Motohiro Sato, Entrepreneurship and Symmetric
Information in Input Markers (Sept. 2005) (unpublished paper, collaboration between
Broadway of Queens University and Sato of Hitotsubashi University), available at
http://www.unicatt.it/Dottorati/Defap/Allegati/Boadway_Seminar.pdf.
51
Cf. id.
52
Cf. id.
53
See generally RICHARD LUECKE, HIRING AND KEEPING THE BEST PEOPLE (Harvard
Business
School
Press
2002),
available
at
http://slava.parma.ru/Doc/Unsorted/New/BOOKS/Harvard%20Hiring%20and%20Keeping%2
0the%20Best%20People%20(2002)%20Fly.pdf.
54
Cf. Carolyn L. Rumfelt, You’re Fired, Twice!, 11 KAN. EMP. L. LETTER, Nov. 2004.
124
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[Vol. 33 No. 1]
is using its capital on someone that is not who they should be in the
business.55
And that’s not an unkind way of dealing with the world. It is just that your
gifts didn’t match what we wanted, so there is a very human way of dealing
with it. You weren’t what we expected, and we need to part ways.
MR. CHERNIAK: Briefly, I think one way to reduce the risk of having
that bad one-on-one chemistry is to try to introduce small syndicates to earlystage deals, having two or three VCs rather than one.
Most VCs are not terribly open to a small investment. What can also
happen is to sort of force capital down the entrepreneur’s throat just to make
the deal work. The entrepreneur can be forced to increase the size of the deal,
take more capital than he or she perhaps needs, in order to allow each of the
funds in the group to deploy enough capital to make the deal worth their
while.
So, you know, you now have two or three VCs, with a nice relationship
with the entrepreneur. The funds sort of keep each other honest, and they
diffuse the power that a VC has going into a relationship with an
entrepreneur. Usually one or more of the funds in the group ends up being
the “good cop” in the relationship, giving the entrepreneur some needed
psychological support.
And in this structure, the funds sort of keep each other in line – even
though it might appear that the relationship would be two or three against one
now, instead of one-on-one – but the structure again sort of balances things
out, frankly, balances the relationship a bit. Really, it kind of diffuses the
power, I guess. I encourage this for deals.
MS. HORTON-PANZICA: I love it, and it works beautifully when it is
just a little more risk than I want to tolerate. If you think of the number of
business plans that we look at, there are hundreds, and the few deals we
actually do, it is not that some of the others didn’t really take me away, I
loved them, but they were just too much risk.56
And so the question is whether we can fund some of those opportunities
by locking arms in our environment, and you know, we are talking about: do
we need venture capital? Absolutely. And we need venture capitalists that are
willing to lock on and say, “You know what? We want to share this risk and
do it.”
And that would enable more deals to be done if we can promote that
collaboration amongst people and investors that have the same ethic.57 You
55
See generally LUECKE, supra note 53.
See generally Brett Nelson, How to Increase Your Venture Odds, VENTURE CAPITAL J.,
May 1, 2005, 2005 WLNR 6846743 (discussing how venture capitalists engage in
probabilistic investing by balancing both risk and return).
57
See generally Michael J. Robinson & Thomas J. Cottrell, Investment Patterns of
56
213
know, that would make a lot of sense to me. If there were ways to promote
that, I would encourage us all as professionals to think about it because it
would be a huge help to the entrepreneurial world.
MR. CHERNIAK: To address the Canada versus U.S. aspect, which is a
key component for this conference, I have found that Canadian transactions
are becoming much more like American transactions. There has been a
definite convergence of the two, and I think it is both good and bad.
Canadian deals and U.S. deals now are really hard to tell apart.58
Ten years ago it was vastly different. I could tell in two seconds looking
at a term sheet, a letter of intent, or nondisclosure, or any other deal
document, whether it was American or Canadian. Now the border is frankly
irrelevant in my business. Our deals, we tend to look into geographic “pods,”
which criss-cross the borders sort of blindly. Most of our analysis is done
east-west. The north-south doesn’t really matter. The East Coast has its own
sort of desires in terms of looking for investments and their own sort of
operating styles. Central has one, and the West has one, but they all crisscross the border.59
And the issue for Canada is that it is a small country, with a pretty small
pool of capital overall, and that it is never going to have the critical mass that
the U.S. market has on several levels.60
You know, there is around $22 - 24 billion of venture capital in Canada in
total, and last year in the U.S. they raised about $27 billion just last year in
the tech field.61 In the 2000 “bubble” era, it was $105 billion, and Canada
raised about $6 billion.62 So the markets differ by orders of magnitude. I
Informal Investors in the Alberta Private Equity Market. 45 J. SMALL BUS. MGMT 47 (2007),
2007 WLNR 4360035 (discussing that investors choosing to invest based on relationships
provide a major source of capital for entrepreneurs).
58
See e.g., Douglas J. Cumming & Jeffrey G. MacIntosh, Venture Capital Exits in Canada
and the United States, 53 U. TORONTO L.J. 101, 101-200 (2002) available at
http://www.rotman.utoronto.ca/cmi/papers/Cummings_MacIntosh.pdf.
59
Cf. Symposium, Global Insight, Venture Impact 2004 Venture Capital Benefits to the
U.S. Economy, NAT’L VENTURE CAPITAL ASS’N 45 (2004) available at
http://www.globalinsight.com/publicDownload/genericContent/07-20-04_fullstudy.pdf
(explaining that Canada and the U.S. have similar investment styles, operating mostly in earlystage investment, and Canada is largely financed by U.S. based venture funding).
60
See generally SME FINANCING DATA INITIATIVE, SMALL AND MEDIUM-SIZED ENTERPRISE
FINANCING IN CANADA – PART IV: PROFILE OF RISK CAPITAL FINANCING (2003),
http://strategis.ic.gc.ca/epic/site/sme_fdi-prf_pme.nsf/en/01063e.html
(“[T]he
regional
concentration of venture capital activity in Canada is endemic to the industry.”).
61
See JEAN-PHILIPPE CAYEN, VENTURE CAPITAL IN CANADA, BANK OF CANADA, (2001),
available at http://www.capitalderiesgo.secyt.gov.ar/pdfs/mundo/canada.pdf.
62
Cf. Press Release, National Venture Capital Association, Private Equity Fundraising
Recedes
in
Fourth
Quarter,
(Jan.
16,
2007),
available
at
http://www.nvca.org/pdf/4Q2006Fundraisingfinal.pdf (stating that in 2006 “venture capital
saw the highest fundraising year since 2001 with 200 funds raising $28.5 billion.”).
125
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[Vol. 33 No. 1]
think that is a big reason why Canada has become much more like the U.S,
and the borders have become really irrelevant.
MS. HORTON-PANZICA: It is really interesting for those people who
look abroad. I tend to look at the world rather than the United States, and I
think what’s interesting is that the rollup strategies of specific VC funds that
are industry based are really exciting. I think those are really fun. If you have
got a client or an entrepreneur that is in a specialist industry, rolling up the
industry globally, a specific fund set up for that purpose with no borders
around it can be a good idea.63
If you are working entrepreneurs and you are advising entrepreneurs or
you are looking for money or thinking about money the other way, I would
encourage for you to look for these net-net funds you could pare into an
investment. Co-invest, or look at a broader strategy that has got no borders to
it.
The world doesn’t operate any longer with borders, I believe. I think the
way that business and industry works is by looking at the global trend of
rolling up an industry and making the most of it and creating a back office
for it.64 What I love to do, the investments I am looking at, which interest me
the most, are not only just a rollup of an industry but to roll up the industry
and create a share back office for that industry using technology so that you
have a complete infrastructure that is shared, lowering the cost of that rollup
and leveraging the assets purely upfront.
Does that make sense to everybody? You are actually creating a back
office for the industry. You are rolling up this complete shared services
model and pulling all the SG & A out of the business, and you drop it into
the back office, and then you have an interesting model. That’s a great rollup
model.
The funds doing that, if you find businesses you can do that with and
invest in upfront and roll it up with venture money, that’s fabulous, but I
don’t look at the border stuff any more. I don’t think it makes any sense.
MR. SANDLER: Except for the lawyers to some extent, it is up to them
to make those borders and to make it as transparent as possible. That’s
difficult in the U.S.-Canada situation.
63
See generally Venture Capital Industry Shatters All Records in 2000, Canada’s Venture
Capital and Private Equity Association, http://www.cvca.ca/files/Resources/2000overview.pdf
(last visited Nov. 23, 2007) (discussing that in 2000 the U.S. invested a record-breaking $103
billion, up by over 73% from 1999 and Canada invested $ 6.3 billion, a 132% increase over
the $2.7 billion invested in 1999).
64
See
generally
DELOITTE,
VENTURE CAPITAL GOES GLOBAL (2006),
http://www.deloitte.com/dtt/cda/doc/content/dtt_tmt_vcreport_01262006%281%29.pdf
(stating that venture capital firms in every region of the world plan to increase their cross
border investments).
215
MR. CHERNIAK: Practically speaking, the government goes out of its
way to make sure there is a border, running counter to those flows. Canada
has some rather curious laws in my mind that limit American capital going
in.65 We dealt with them for years in terms of the partnerships and limited
liability corporations.
And that’s a very popular structure in the U.S.66 Venture capital and
private equity funds are structured as partnerships.67 And for whatever
reason, Canada has always had in its mind that they want to limit the ability
of those funds to invest in Canada.68 I never understood this; there is no
benefit in my mind.
I am just trying to compress the topic into a very brief statement. I guess it
tends to affect VCs more because at the end of the day there are a lot of ways
around it in terms of having the proper tax advice and doing all the filings
and doing all these sorts of regulatory administrative things we need to do to
make sure that you are on site.69 All the partners can file tax returns and do
all their certificates and things, but this adds time and cost to transactions,
and the VC – for them it is much more critical because it is a very different
business than the private equity business.70 The dollars involved are much
smaller, so the administrative and time and cost and risk of these barriers are
much more onerous; they can and do kill venture capital transactions.71
MS. HORTON-PANZICA: Isn’t the real barrier that you can’t make as
much money? I mean, the deals – and I am going to come back and be my
65
See THOMSON MACDONALD, THE ACTIVITY OF AMERICAN VENTURE CAPITAL FUNDS IN
THE
ONTARIO
MARKET:
ISSUES,
TRENDS
AND
PROSPECTS
(2005),
http://204.15.35.174/images/uploads/ThomsonMacdonald1105.pdf (noting that American
investors state that a range of tax issues arise when engaging in cross-border activity with
Canada resulting in deals becoming too costly or complex).
66
See William L. Megginson, Towards a Global Model of Venture Capital? 12 (The
University
of
Oklahoma,
Working
Paper,
2001),
available
at
http://www.milkeninstitute.org/pdf/Megginson.pdf.
67
See id. at 8-9.
68
See generally MACDONALD, supra note 65.
69
See generally id. (discussing that under the Canada-United States Tax Convention,
American LLCs are subject to taxes arising from their investments in Canada, thus some
American corporations choose to affiliate with Delaware corporations and other non-Canadian
corporate entities to avoid taxes and other strictures; further, non-resident investors must also
file a Section 116 certification when disposing shares in a private Canadian firm – the process
can be tedious and can jeopardize returns; other related disclosure requirements are also said
to be intrusive).
70
Id. (stating that despite the Delaware strategy and other methods used to facilitate crossborder activity, investors still see investing in Canadian companies as “complex, timeconsuming and expensive.”).
71
Id. (stating that investors interviewed argued that the costs of investing in Canadian
companies “were prohibitive in certain transactions, leading them to consider only those
opportunities where they can make exceptionally large investments in Canada.”).
126
216
[Vol. 33 No. 1]
own devil’s advocate – but the perception of the VC opportunity in Canada is
that you just don’t have any ROI. The ROI is so much smaller than putting
money at risk in the United States that you just can’t drive U.S. dollars into
the Canadian market.72
MR. CHERNIAK: Yeah, there are those perceptions.
MS. HORTON-PANZICA: Saying that, I did two deals in Toronto, so I
am going to make money on those deals, but I chose those deals
specifically.73 I think the perception is you can’t make money in Canada.
MR. CHERNIAK: Oh, yeah.
MS. HORTON-PANZICA: I think there is that whole piece, that, you
know, you cannot put money to – if you put money to work there, you can’t
get it to work.
MR. CHERNIAK: No, I agree with you completely. Actually, look at the
20-year return on venture capital in Canada: it is low single digits; and in the
U.S., it is about 20 percent.74 And in the last five to ten years, after the 2000
bubble, those returns converged.75
The five-year U.S. return is low teens if I recall correctly, which is not
bad, better than Canada but not a home run, on average. But by every
measure, one-year, five-year, ten-year, twenty-year, Canada does trail the
U.S. in venture capital returns.76 And one of the reasons, frankly, is that it is a
structural thing. I don’t think it is necessarily fundamental to Canadian
companies. It is issues like the labor-sponsored funds, which were
government-incentive vehicles to, for reasons other than pure investment
fundamentals, put capital into the capital markets.77
72
See generally CAYEN, supra note 61 (stating that in the Canadian venture-capital
industry there is “a high risk of making little profit or even of incurring losses.”).
73
Id.
74
See generally Charles Plant, Lightweights in a Heavyweight World, RED CANARY, Aug.
20, 2006, http://www.redcanary.ca/view/lightweights-in-a (last visited Nov. 8, 2007) (“Rates
of return for venture capital investments in Canada for all measurement periods and for all
stages of investing are in single digits or negative.”); cf. Press Release, National Venture
Capital Association, Venture Capital Out Performance Holds Steady in Period Ending Q1
2007, (Aug. 2, 2007), available at http://www.nvca.org/pdf/Q107VCPerformanceFINAL.pdf
(stating that the U.S. venture capital twenty year returns of 16.4%).
75
See generally Jim Casparie, Raising Money – Can You Really Land Venture Capital?,
ENTREPRENEUR, Mar. 31, 2006, available at http://www.entrepreneur.com/money/financing/
raisingmoneycoachjimcasparie/article84246.html (explaining that “when the ‘dot com’ bubble
burst and the IPO and mergers and acquisitions (M&A) market virtually disappeared” venture
capital firms experienced difficulty receiving a return on their investment).
76
See generally Plant, supra note 74.
77
See generally Douglas Cumming, Financing Entrepreneurs: Better Canadian Policy for
Venture Capital, C.D. HOWE RES. INST., Apr. 15, 2007, 2007 WLNR 9872149 (stating that
Labour-Sponsored Venture Capital Corporations (LSVCCs) are Canada's key venture capital
initiative to facilitate entrepreneurial investment).
217
They thought the necessary risk capital to support the entrepreneurial
underbelly of the economy was not going to come from the private sphere, so
they initiated a 30% tax-credit incentive, in order to draw the capital in.78
Every dollar you put in, you get 30 cents back via a tax credit, but the
problem is the labor-sponsored world created specific rules that these funds
had to maintain to keep their status.79 Well-meaning rules that are, in some
cases, silly. For example, one was called the “pacing rule,” which essentially
meant that the government would dictate how quickly you have to spend the
money you raised. And so every November, December typically in the
Canadian capital markets, you have LSIFs running around like drunken
sailors with their wallets open saying, “I’ve got to spend this money before
year-end. I almost don’t care what I do with it. Is it even remotely a
reasonable opportunity? If it is, here you go, take my money because it is
December. I would have turned the deal away in May!” So there is no way to
tell scientifically, but initiatives like these must have hurt returns in the
Canadian markets.
MS. HORTON-PANZICA: I think that the statistic here, which you
produced, I thought, was unbelievable. It was very great.
MR. CHERNIAK: Yeah, for ten years.
MS. HORTON-PANZICA: Yeah.
MR. CHERNIAK: No. That is skewed by the fact that in the bubble, U.S.
investors were making returns that were just off the charts – “thousand
percent” returns. If you look at the longer five-year or ten-year U.S. return, it
is much more normal.80 So 20 percent is not sort of a stable return, but it is
still, again, big. The U.S. return is better.
MS. HORTON-PANZICA: What would really be interesting actually
would be a study of returns on the specific industry sector funds because, if
you looked at the returns that were specifically from the Canadian cluster, I
bet those returns are fabulous.
So what we have is a mix of all invested monies. I presume that Canada
could have an incredible forestry fund venture or whatever assets are up in
Canada that I am not aware of, if you think about what assets Canada has and
think about how they can be ventured and put into specialist funds and rolled
78
See Ayi Ayayi, Public Policy and Venture Capital: the Canadian Labor-Sponsored
Venture Capital Funds. 42 J. SMALL BUS. MGMT 335 (2004), 2004 WLNR 9619980 (stating
that a benefit to investing in a labor sponsored venture capital fund is a 30-percent tax credit
on the investment).
79
See generally Cumming, supra note 77 (stating that LSVCCs are bound by many
statutory constraints, including “requirements to reinvest fixed percentages of contributed
capital in private entrepreneurial companies within a stated period of time.”).
80
See generally Press Release, National Venture Capital Association, supra note 74
(stating that five-year and ten-year returns on U.S. venture capital is 2.7% and 21%
respectively).
127
218
[Vol. 33 No. 1]
up as a global industry. That’s where Canada can make a mark. I mean,
Canada can make a mark by using its asset base to petition for venture funds,
and maybe that’s why this is skewed.
MR. SANDLER: Part of the reason why it is skewed is because there is
no breakdown between labor-sponsored funds and private venture funds.81 I
think the labor-sponsored funds return certain rollups.
MR. CHERNIAK: Yeah, absolutely. I did sort of a rough calculation on
the fly when I was in the business and, absolutely, the overall return for the
labor-sponsored returns is fairly dismal.82
MR. SANDLER: Negative in many cases.
MR. CHERNIAK: Yeah. In some cases, they were specially focused
funds that had shackles that American funds or other sort of generalist
venture capital funds didn’t have.83 The one, which I worked with, their
charter was to invest in small, capital intensive, labor intensive businesses in
the province of Ontario. And that was right around the time that the Indian
and Chinese offshore manufacturing assault was hitting its peak. You did the
best you could, but when your focus is that specialized and tragically flawed,
frankly, let’s just say that chunk of capital didn’t do very well.
MR. SANDLER: That’s labor.
MR. CHERNIAK: Yeah.
DISCUSSION FOLLOWING THE REMARKS OF BRAD D. CHERNIAK
AND CATHY HORTON-PANZICA
MR. SANDLER: Aren’t there a couple of questions or comments?
DR. KING: Yeah. I had a question. It seems to me the ultimate source of
success or failure is technology, and I would like to ask Cathy and also Brad
about technology reviews.
Do you have somebody on your staff – or do you have a group that
reviews it before you take the plunge or before you take – or do take the
entrepreneur’s word for it?
MS. HORTON-PANZICA: It is interesting because my partner, he and I
between us probably have 40 years of tech or technology experience. So we
actually are very deep technologists. Between us, he covers very much
81
See generally Cumming, supra not 77 (arguing that labor sponsored funds “have
become the dominant source of venture capital” in fact, “government tax subsidies to
LSVCCs may crowd out private venture investment.”).
82
Id. (“[E]vidence suggests LSVCCs are inefficient investment vehicles, charging high
fees and yielding disappointing results: very few funds generate positive returns.”).
83
Id. (explaining that statutory constraints on labor-sponsored venture funds “include
limits on the geographical range of investment opportunities to within the sponsoring
jurisdiction, [and] constraints on the size and nature of investment in any given entrepreneurial
company.”).
219
healthcare and bio and the alternative energy field, and I cover really
systems.
I worked for a leading vendor for about ten years as a lead outside
counsel, and they taught me everything to do with systems. I understand
everything having to do with information technology and how systems can
be improved and driven. Between us we can really hit the analytics and hit
the patent world and really understand there is a place.
What is the patent world, and how do you analyze it? It is just like real
estate: I think the easiest way to explain it for me as an investor is that it is
just virtual real estate, and there is only so much of it.84
And do they have a parcel that is going to be worth something, or is it a
parcel that is not situated well and doesn’t have any beach view and doesn’t
have any sand? What are the amenities, and what is the possibility of this
little piece of real estate they own, which is called intellectual property?
If you are blessed enough to be able to look at that intellectual property
and say, “Oh, my gosh, I want to buy that,” I think the people that understand
intellectual property are just like real estate moguls. They get the property
they are looking at, and they understand what it can be.
If for some reason I don’t have the skill set in-house to determine whether
that’s a good investment because it is something that is really a specialty
area, then, yes, I have outside people I retain. They will scrub it down for me
and give me a response.
MR. CHERNIAK: Yeah. In Canada, it can be very difficult just given the
size and lack of depth of investments in any specific vertical to have in-house
expertise. For technology-related deals or IP-related deals, you tend to bring
in a third party. However, you tend to lose something with that method.
They issue a report, and then it is not quite the same thing as having the
sort of in-house talent, fully motivated to be right.85 And that is what has
driven so much of the specialization in the U.S., of funds that bring on
software developers and bring in veteran entrepreneurs from specific
companies that fit with their charter.86
84
Mario W. Cardullo, Intellectual Property – The Basis for Venture Capital Investments,
INTELLECTUAL
PROPERTY
ORGANIZATION,
available
at
WORLD
http://www.wipo.int/export/sites/www/sme/en/documents/pdf/venture_capital_investments.pd
f (explaining that venture capitalists should carefully analyze the economic value of a patent, a
trademark, software, a domain name, and any intellectual property in order to determine when
and whether to invest).
85
See generally, Canadian Venture Capital Activity: An Analysis of Trends and Gaps
(1996-2002), SME Financing Data Initiative, http://strategis.ic.gc.ca/epic/site/sme_fdiprf_pme.nsf/en/01182e.html (last visited Nov. 23, 2007) (arguing that in order for the
Canadian venture capital industry to grow, the country needs skilled and experienced VC fund
managers that can evaluate and identify potential high growth investment opportunities on
their own).
86
See, e.g., Paul Gompers et al., Venture Capital Investment Cycles: The Role of
128
220
[Vol. 33 No. 1]
You have companies in the U.S. who just do enterprise software or just
marketing applications. And they bring in guys who have run those kind of
companies and can assess the technology. In Canada, it is much more
difficult. You are forced by the nature of the market to be more of a
generalist.87
MR. DELAY: I am an attorney. When small businesses are setup
somewhere in the United States, counsel will tell the ambitious founder that
they have to remember that a new business could take twice as much money
and five times as much time as they originally estimated, and they’ll discuss
with the attorney at that time about reaching a profit.88 They try to curb the
enthusiasm of the curve and let them know it will take longer and twice as
much money.
In your experience, is that still a good rule-of-thumb in the American
experience with the VC’s capital? Is that a good rule-of-thumb?
MR. CHERNIAK: Absolutely. It is one of the key reasons why we started
Sapient Capital. Probably the biggest chunk of time we spend with a client is
to model in detail what the business is going to look like and not just kind of
blue sky, not just sort of soft and meaningless numbers. We nail it down to a
single employee and here we also apply current market principles as to what
that person is going to cost you.89
So we spend a lot of time saying, “What do you really need to target the
market you are going after?” and it is a detailed exercise because it often
surprises them in terms of how much money they need. We help determine
and prioritize strategic goals. We can help by using our experience to tell
them how realistic is it to achieve, say, four of these goals within six months,
or whatever.
You probably have to spread them over a longer period of time, be more
conservative in terms of what it is going to cost you and what your sales
ramp-up is going to be.90
Experience
and
Specialization
24
(2004),
available
at
http://www.law.upenn.edu/ile/SeminarPapers/Gompers%2011.11.04.pdf.
87
Canadian Venture Capital Activity, supra note 85.
88
See generally, Jeff Wuorio, 7 Good Reasons to Call a Lawyer, MICROSOFT SMALL
BUSINESS
CTR.,
http://www.microsoft.com/smallbusiness/resources/finance/legal_expenses/7_good_reasons_t
o_call_a_lawyer.mspx (last visited Nov. 8, 2007) (explaining that attorneys are essential to
any small business operation in reviewing the business structure, evaluating exit strategies and
managing finances).
89
Id.
90
See generally Asheesh Advani, How to Forecast Revenue and Growth, ENTREPRENEUR,
MAR. 7, 2005, http://www.entrepreneur.com/money/financing/startupfinancingcolumnist
asheeshadvani/article76418.html (explaining the need for business owners to “[f]orecast
revenues using both a conservative case and an aggressive case.”).
221
MS. HORTON-PANZICA: I think every investment is different. I like it
when the venture capital world tailors investments to the circumstances. The
investment we made in New York – and we were out in six months – was
tragic. I wanted to be in that deal. It just depends, if the real estate is that hot,
somebody is going to want it. I think about it like property. If you have got
that corner lot sitting on the beach, somebody is going to buy it real fast. If
you have one that is further down and a little bit back from the beach, it
could be harder to sell.
Certainly, my specialty is technology companies. So I think it is a lot like
that, and you have to look at how soon that property is going to be wanted in
the marketplace. If you think about it like that, and analyze the IP like that,
you actually can predict cash flow pretty well, and you can predict time to
market pretty well.91 Think about it like real estate.
MR. JEFFERS: I had a question. You have talked a lot about getting into
deals and about working with your entrepreneurs. What happens when things
go south and you have a failure on your hands? One among you is a priest.
You know, is there a possibility of absolution?
I am just wondering if either of you, in your experience, follows a sort of
template where you perhaps sit down, and you conduct a sort of autopsy of
what went wrong.
Are there occasions when you, perhaps, will look at the individual and say
this just didn’t work for one or other reasons? It doesn’t mean that you are a
bad person. In fact, you may be a very good person, and, maybe in the future
we will deal with you again.
Have you come across situations like that?
MR. CHERNIAK: Yeah. From my own experience, I find that I have
seen several that turned into restructurings and ultimately disasters. And
really it is a slow motion train wreck. It doesn’t happen so quickly that you
don’t see it coming and you can’t talk with the entrepreneur in the trenches
over weeks or months. So you tend to see it coming. I think it depends on
how you deal with it as you are going through it.
There is no need for a forensic post-event assessment, because you have
gone through it live in terms of making sure everyone understands there is no
fault here, that everyone has tried their best, but that in some cases you are
dealing with exogenous factors, like the India/China manufacturing
phenomenon, that simply eviscerates domestic manufacturers on cost. It is
not that the failed entrepreneur is an idiot. And you just make that clear
during the process.
MS. HORTON-PANZICA: That’s a really interesting question because I
have had a couple of entrepreneurs who, because they are so disappointed in
91
See generally Cardullo, supra note 84.
129
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[Vol. 33 No. 1]
themselves, they just sort of exude that across everybody that has anything to
do with them. And I tend to just take it.
There are a couple of young chaps I was thinking about in my London
investment days where I sat down and really tried to help them see why they
failed and why we failed. One in particular I am thinking about just didn’t get
the market position right. Today I am a different investor.
I think I very rarely just invest money to invest money anymore because I
find that I can’t effect when a business is getting into trouble. I had a
business a couple weeks ago that was in trouble. They just weren’t getting
customers that they needed to get in the door. I just gave about two weeks of
my time doing gorilla marketing. It is cash flowing as of last week. I mean, I
just did it and gave my skill set. One of my skill sets happens to be customer
attention and attraction, and I just went in and did it. If I didn’t have that skill
set in a business that I invested, we would get it. We would fix it.
I don’t let things that I have invested in or groups I have invested in that I
am responsible for get there. But you have to make investments where your
investees will let you do that. They understand and respect you enough that
they want you to come in and help.
I said, look, I have been in London. I came back. You are in trouble. You
don’t have enough feet through the door. You are in trouble. And I am just
going to gorilla the market. What are you going to do? We sent out 4,000
flyers for this business and, you know, today it is cash flowing.
It was just simple street market. They were doing all this high-level stuff,
radio, TV – expensive stuff. I said, “Look, what happened to shoe leather?”
We corrected it.
I am into making investments where I can make a difference. I think
different venture people are different. They want to give it time or they don’t.
Some of them are just hands off – they put in the money and think that they
can walk away and not put a lot in it. I mean, the venture money is really,
really important. Certainly, if you want the money of people I represent and
people I work with, it would be to say, you know, it is an alternative, and we
don’t get to that point. We would intervene.
DR. KING: Dan, we are getting near the noon hour.
MR. SANDLER: Yeah. Is there a question right behind you?
MS. HORTON-PANZICA: It is also kind of nice because it is almost
lunch.
MR. SANDLER: Do you have one more question?
MR. GROETZINGER: If you have an entrepreneur come to you with a
great new idea, identified a niche market, looks like it will go but not terribly
protective, being, in other words, it will be hard to patent it or trademark,
whatever way you want to protect it – do you make up the fact that it is not
so protectable by aggressive marketing, or does every investment you make
223
have to have some element that will prevent competitors from coming in and
having significant barrier entry?
MS. HORTON-PANZICA: Are you asking me?
MR. GROETZINGER: Either.
MR. CHERNIAK: Yeah, I can answer that, or if you want to take it
Cathy, please do.
MS. HORTON-PANZICA: I love intellectual property. I tend to look for
stuff that I can see is going to make it because I can see the real estate. If it
looks fun and exciting, I probably would get a bunch of people to put in
some money and have a little fun with it, but it wouldn’t be something that
would turn me on.
I really love the world of intellectual property. I know we have that on the
stage later, but I think intellectual property is incredibly exciting for venture
capitalists. Why? If you understand the intellectual property, you can
commercialize it.
If everything goes to hell-in-a-hand-basket, you still own the property,
still own the corner with the beach view. You just didn’t build a very nice
house. So you tear down the house, and it is still the property, right? That’s
what I love, and that’s what gets my boat floating, but you may have a
different spin on that.
MR. CHERNIAK: I took a little bit of a different tack in the sense that
you certainly want the intellectual property. I took the view that most
businesses are really service business, and I go in it with the presumption that
you are not going to be able to protect it, and that there may be, in a real
practical sense, nothing to protect anyway. Companies had to constantly be
innovating to stay ahead of the curve and spent too much time looking back
protecting past initiatives rather than forward to the next initiative.
In that case, how well have you identified your customers, and what are
you providing to them? And if you try like hell and you market like crazy
and you do everything, you work as hard as you possibly can, can you defend
that for any period of time? And if I see enough runway, I would probably do
it because if you are successful in that regard, chances are you are going to
be able to sell out to somebody that has more IP.
You become a tuck under to somebody else’s technology in a sense. At
the end of the day, as long as the business makes sense to me, that’s the first
order of defense and not the IP specifically, whether it is patented and what
the prior art position is. That’s a second level, but it is still critical and
especially – I mean, I don’t know what specific sector we are talking about.
Also, it varies in terms of what type of business, but overall –
MS. HORTON-PANZICA: When I refer to intellectual property, I refer to
intellectual property as a basket of intellectual capital. It is more than just a
registered patent for me. I mean, is there something here that is protectable,
that I can put up a fence on my property and keep you out?
130
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[Vol. 33 No. 1]
MR. SANDLER: That’s a good question that we can take up at 2:15 with
the IP subject, but unfortunately, I think we have to draw this one to a close.
MR. UJCZO: Lunch will be held upstairs where we had dinner last
evening for those of you that were here, but it is directly upstairs where we
ate lunch yesterday.
WHERE DO THE UNITED STATES AND CANADA STAND
VIS-A-VIS OTHER COUNTRIES REGARDING
ENTREPRENEURSHIP?
Session Chair – James McIlroy
Speaker – Dr. Robert Hisrich
INTRODUCTION
James McIlroy
MR. McILROY: I would like to call this meeting to order again. As you
know, this is the ninth session, so we are about three quarters of the way
through our program. And in case you haven’t noticed, the program is “The
Comparative Legal Aspects of Entrepreneurship in Canada and the United
States.”
What I would like to do just to briefly kick off this session is to focus for
a couple of moments on a couple of titles, and the first title I want to focus on
is the title of this session, which is “Where Do the United States and Canada
Stand vis-à-vis Other Countries Regarding Entrepreneurship?”
So in effect, what we are doing here, and what we have done for the last
day and-a-half, is compare Canada, on the one hand, to the United States, on
the other. We are going to go a little beyond that in this session in that Dr.
Hisrich is also going to compare where Canada and the United States fit in
vis-à-vis other countries around the world. So it is more of a comparative
approach than we have seen thus far.
That’s the title of the session; let me move to the title of our speaker: Dr.
Hisrich. He is the Garvin Professor of Global Entrepreneurship and Director
of the Center for Global Entrepreneurship at the Thunderbird School of
Global Management. So you hear the word “global” there no less than three
times. And, I think, just looking at his title you can tell that he is very, very
qualified to speak on how Canada and the United States fit into the global
order of entrepreneurship.
Now, as you may note, the Thunderbird School of Global Management is
located in Arizona, and its mandate is: “We educate global leaders who
create sustainable prosperity worldwide.” So it is very much an institute that
is in keeping with the theme of this program. And if you look at Dr. Hisrich’s
225
131
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[Vol. 33 No. 1]
background, you will see that he is eminently qualified, both from a scholarly
perspective and also from a hands-on perspective.
Let me deal first with his scholarly background. Although he resides in
Arizona now, Dr. Hisrich is no stranger to Ohio. He attended the University
of Cincinnati where he obtained two degrees, his MBA and a Ph.D. He
taught here for ten years, as some of you heard yesterday, and he built a very
successful business program here at Case.
Now, in addition to his strong academic foundation, Dr. Hisrich has very
extensive hands-on international experience, including his work in a couple
of countries where you don’t really think of entrepreneurship – that is a
couple of countries that came out of the demise of the Soviet empire – and
that is Russia and the Ukraine.
He is also a very prolific writer but he does not reside in an ivory tower.
He has authored or co-authored over a dozen books, many of which are very
successful, and they are listed in your program.
Given his expertise and his experience, we are going to be in for a very
stimulating session. So I would ask you to please join me in welcoming Dr.
Robert Hisrich.
SPEAKER
Dr. Robert Hisrich∗
DR. HISRICH: Thank you, James. Thank you very much for a wonderful
introduction. James forgot to tell you that one of my books is How to Lie
With Your Resume.
It is really thrilling to be here for a couple of reasons; particularly, it is
good to be back to Cleveland. I had ten great years here at Case Western
∗
Dr. Robert D. Hisrich is the Garvin Professor of Global Entrepreneurship and Director
of the Center for Global Entrepreneurship at Thunderbird. In addition to his M.B.A. and Ph.D.
degrees from the University of Cincinnati, Dr. Hisrich has honorary doctorates from Chuvash
State University (Russia) and the University of Miskolc (Hungary), and held Fulbright
Professorships at the International Management Center in Budapest and the Foundation for
Small Enterprise Economic Development. He has authored or co-authored fourteen books,
including Entrepreneurship: Starting, Developing and Managing a New Enterprise in its 7th
edition and Small Business Solutions: How to Fix and Prevent the 13 Biggest Problems That
Derail Business. Dr. Hisrich has served on the editorial boards of The Journal of Business
Venturing, Entrepreneurship Theory and Practice, Journal of Small Business Management,
and Journal of International Business and Entrepreneurship. He has instituted academic and
training programs such as an entrepreneurship training program for high school teachers in
Russia and college level programs at the Institute of International Entrepreneurship and
Management in Russia and the Entrepreneurship Center in the Ukraine.
Hisrich—US and Canada vis-a-vis Other Countries
227
Reserve University creating what ended up to be ranked fifth in the world, an
entrepreneurship program, before I left. And I have created two companies
here that are doing very well, one in the medical software field and another
one in medical devices.
And so I have really enjoyed my time here in Cleveland, and it is always
good to be back to this part of the world. Similarly, it is always good to have
Canadians here. I love your country. Basically, it is an economic love.
When I was at MIT, as a professor, we created a company called Polymer
Technology, and we made the Boston lens, which was the first gas permeable
hard contact lens in the world.1 I had tremendously good patents on the lens –
five patents that were almost unbreakable; we did not want to take the money
to get FDA approval in the United States because we would have had to sell
quite a bit of our company. So we went to Canada, and you made us a lot of
money. I appreciate that a lot.
I particularly like Toronto because that’s where we started. We obtained a
distributor there – Boots Drugs and others distributed our solutions.
The company was later sold to Bausch & Lomb, so I am out of the lens
business, but it was fun. When Henry called, two things concerned me: One,
he said I want you to address this topic in 30 minutes. Of course, you know,
you never say no to Henry, and never question how much time you are going
to have; I thought how am I going to address global entrepreneurship in 30
minutes? Second, Henry indicated that I was on the program after lunch. I
thought, “you never have a great audience after lunch, everybody is half
asleep.” In spite of these two negatives, it is fun to be here, and I know we
are going to have a good time exploring this very important topic.
I am more eager for your questions than my talk as I talk all over the
world. But I want to set the stage for looking at this topic of global
entrepreneurship around the world. Let’s first think together what it takes to
form a company, as that’s what we do as entrepreneurs.
I am going to address this topic through three lenses: one, from the
academic lens because I’ve studied this process all over the world; two, from
the entrepreneur lens, having created multiple companies both here and in
Hungary and Russia and now one in China; and three, from a theoretical lens
as we should understand some of the theory behind it. What does it take to
form a company? Four things.
Number one, you have to have the idea. That’s number one. We heard
that talked about today in terms of the venture people. You need an idea that
makes sense; most ideas aren’t a business. When Mal was speaking, he said
one out of a hundred people fail. There is a high failure rate in business start
1
See
Poly(ethylene
oxide)
coated
surfaces,
Patent
Storm,
http://www.patentstorm.us/patents/6616982-description.html (last visited Sept. 27, 2007).
132
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[Vol. 33 No. 1]
ups and about one out of a hundred ideas I see actually could be the basis of a
business. You need to have the right idea.
All around the world there are innovation and ideas. While some
companies are a little more innovative than others, but even in Hungary,
under socialism and Soviet control, there was the Rubik’s Cube. When I was
in Hungary in 1989 living under the Soviet days, I saw a woman retailer who
had the most beautiful vegetable stand that would be an incredible
merchandising tool anywhere in the world. There is some degree of creativity
and innovation all over the world.
The second thing you have to have is money. I have had venture money
behind two of my companies – which is a particularly interesting topic all on
its own; you need money, particularly money for startup.
In the United States, we are very fortunate. It is not the venture capital
industry that affects entrepreneurs in the U.S. at startup but it is what you
heard yesterday: the angel market. These angels are private individuals
investing in companies.2
We did a study of U.S. companies asking, “Outside of family and friends
and your own money, where did you get your funding to start your venture?”
Eighty-seven percent of those companies received their funding from private
individuals.3 That’s the key to the U.S. economy. Are we entrepreneurial?
Yes. Do we form more companies than anywhere else in the world? Yes.4
But it is the angel money in the United States that is so critical to
entrepreneurs. That’s what I am trying to develop as a member of an
advisory board in the country of Slovenia; the goal is to provide startup
capital and help Slovenians understand the importance of investing in startup
companies.
Private individuals investing in a startup company is not happening
anywhere in Europe or other countries in the world.5 And this money is
available in every one of these countries. There is wealth in China.6 There is
2
Clark S. Judge, The Tax That Ate the Economy, WALL ST. J., June 24, 1991, available at
http://www.whwg.com/thefirm/sample.php/60/Clark_S._Judge.
3
See generally, Stephen D. Prowse, The Economics of the Private Equity Market, ECON.
&
FIN.
POL’Y
REV.,
Q
III
1998,
21,
available
at
http://ideas.repec.org/a/fip/fedder/y1998iqiiip21-34.html#download.
4
See generally, Maria Minniti & William D. Bygrave, National Entrepreneurship
Assessment United States of America: 2003 Executive Report 7 2003 GLOBAL
ENTREPRENEURSHIP
MONITOR
available
at
http://www.kauffman.org/pdf/gem_2003_us_report.pdf.
5
Id. at 10.
6
Shi Li & Renwei Zhao, Changes in the Distribution of Wealth in China, 1995-2002 19
(January 2007) (United Nations University – World Institute for Development Economics
Research ed. 2007) available at http://www.wider.unu.edu/publications/rps/rps2007/rp200703.pdf.
229
wealth in Slovenia.7 There is wealth in Croatia.8 There is wealth in Hungary.9
How do we get that money to work for the betterment of the country’s
economy, as well as the individual entrepreneur? A country needs to
incentivize these individuals to invest a percentage of their wealth in startup
companies. I don’t see this occurring anywhere else I have been outside the
U.S. You need money.
The third thing you need is the entrepreneur. The entrepreneur takes the
idea (either his idea or from an inventor) to the marketplace. He or she is the
driver of that particular product and idea.
I have studied entrepreneurs all over the world, and the interesting thing –
which is really nice for entrepreneurs doing international business – is that
they are more similar than different. We are “crazies” as I heard some
venture people say. I am glad I am “crazy” because I love the process. I am
passionate about the process. I understand the process and actually undertake
the process. I meet entrepreneurs in China, Russia, Hungary or Ireland and
they are very similar. We are more similar than different.
For example, in one study of entrepreneurs, we asked, “What motivated
you to start your business?” The same comment was made, whether it was
from a Russian or a German or an American entrepreneur: “We can’t work
for anyone else. We want to be independent.” You heard Mal Mixon mention
this the other day. Entrepreneurs want independence; they want to be their
own boss.
The second reason given in terms of motivation for starting a business
was that they want to make money. The third reason was that they are
passionate about the idea and want the product/service on the market. They
are really passionate about their ideas. These two reasons were also similar
all over the world.
The only difference between men and women, in terms of these
motivators across countries, was women had passion about the idea as
second, and money as the third. These three reasons accounted for around 70
percent of the responses.
Entrepreneurs are also similar in two other aspects. One is the decision
process in becoming an entrepreneur. We have to make a decision to go from
something to something, as is indicated in Table 1.
You have to change lifestyles if you are not presently an entrepreneur
because it is a different way of life. You heard Mal talk about the fluctuations
7
E.g., Daily Says Mirko Tus the Wealthiest Slovenian, Republic of Slovenia Government
Communications
Office,
http://www.ukom.gov.si/eng/slovenia/publications/slovenianews/4445/4457/ (last visited Sept. 27, 2007).
8
E.g., Mislav Šimatovi , Croatia’s 50 Wealthiest, 597 NACIONAL: NEOVISNI NEWS
MAGAZIN, Apr. 4, 2007, available at http://www.nacional.hr/en/articles/view/33809/18/.
9
E.g., Eszter Balázs, Fotex Boss Tops List of Countries Richest, BUDAPEST SUN, Nov. 28,
2002, available at http://www.budapestsun.com/cikk.php?id=14776.
133
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[Vol. 33 No. 1]
in wealth and the fluctuations in security you have. That’s all part of the
process. The majority of people can’t handle that. You need the ability to be
flexible to form a new enterprise. What causes us to do this? It has to be
desirable. What makes it desirable? This desirability is different for
entrepreneurs in various countries.
One aspect of the country is that its culture needs to support
entrepreneurship. The culture has to look at entrepreneurship as a positive
element. Entrepreneurship is not looked at very positively in Austria.10 It is
looked at negatively in Russia.11 The culture in the United States, and the
culture in Canada, is pro-entrepreneurship.12 But even in a proentrepreneurship culture, there will be pockets of entrepreneurship. A total
culture isn’t entrepreneurial; it contains pockets of entrepreneurship.
Look at the United States: we have pockets of entrepreneurship. Where
are they? The major ones are: Silicon Valley, Route 128, and North Carolina
Triangle.13 That’s where the heaviest emphasis on entrepreneurship is;
entrepreneurs like to cluster together. So it is really the subcultures that drive
entrepreneurship.
When I was in Ireland in 1984, the Irish economy was terrible. It was one
of the worst economies in the European Union in 1984 – high debt ratio,
something like 35 percent.14 Some homes did not have telephones. The
economy was in terrible shape.15 We started teaching entrepreneurship at the
University of Limerick, which is on the Limerick side, and in Dublin at the
University College Dublin, then in Cork and in Galway.
Then a coalition between the government, the universities, and businesses
was formed. Now the Irish economy, in just 20 years, is one of the strongest
in Europe.16 What a tremendous transformation. When a minister in the
10
See generally, Laura d’Andrea Tyson et al., Promoting Entrepreneurship in Eastern
Europe, 6 SMALL BUS. ECON. 165 (1994).
11
Id.
12
DAVID BOLLIER, THE GLOBAL WAVE OF ENTREPRENEURIALISM: HARNESSING THE
SYNERGIES OF PERSONAL INITIATIVE, DIGITAL TECHNOLOGIES, AND GLOBAL COMMERCE 14
(The Aspen Institute 1999) available at http://www.bollier.org/pdf/globwave.pdf; SHERRILL
JOHNSON, YOUNG SOCIAL ENTREPRENEURS IN CANADA 4 (Canadian Centre for Social
Entrepreneurship School of Business, University of Alberta 2003).
13
See, Kurt Badenhausen, Best Places for Businesses and Careers, FORBES, May 5, 2005,
available at http://www.forbes.com/2005/05/05/05bestplaces.html; Tyson, supra note 10, at
36, 38.
14
Róisin Ní Mháille Battel, Ireland’s “Celtic Tiger” Economy, 28 SCI., TECH., & HUM.
VALUES 93 (2003).
15
NAT’L COMPETITIVENESS COUNCIL, OVERVIEW OF IRELAND’S PRODUCTIVE
PERFORMANCE,
1980-2005
6,
http://www.competitiveness.ie/ncc/reports/ncc_productivity_1980-2005/
ncc_productivity_1980-2005.pdf (Ireland is still behind the rest of the EU for many utilities).
16
Battel, supra note 14, at 93.
231
government said, “Let’s have entrepreneurship throughout,” I said, “That
will not be possible. There are going to be pockets of entrepreneurship,” and
indeed, that is what has occurred today.
Families also make a difference. Entrepreneurial families beget
entrepreneurs. Teachers make a difference; some exciting teachers really
stimulate students to become entrepreneurs. Finally, entrepreneurial role
models make a difference. Entrepreneurs like to associate with entrepreneurs.
You need an environment where entrepreneurs can get together and solve
each other’s problems. That’s what we enjoy the best. That’s what makes it
desirable. What makes it possible? The government. That’s what I want to
focus on because that’s the biggest difference in various countries.
When you look at company formation in Canada, the United States,
Germany, China, and Austria, it is the government and the infrastructure set
up that makes the company formation process different, either easier or more
difficult.
The background of the entrepreneur makes a difference, whether we are
technology push or market pull. As you can tell from Mal’s talk yesterday, he
is a market pull entrepreneur. I knew Kenny Olson (who founded DEC)
when he and I were on a board of trustees together. Kenny Olson believed if
he had the best technology, he would always win. Digital Equipment is not
around today. There has to be a blend between the technology and the market
to be successful.
So that’s the decision process that entrepreneurs go through, whether in
Canada, the United States, Germany, China, or Russia.
The second thing that is the same is the four-stage entrepreneurial process
we go through in forming a company (see Table 2). In the first stage, an
entrepreneur needs to identify and evaluate the opportunity. It is all about the
idea. We need to have an idea that is the basis for a business. If this idea can
be protected, as talked about today in a previous session, it is even better. I
try to obtain market protection on my products if they are not patentable.
Most entrepreneurial concepts aren’t patentable.
You need to develop a business plan, particularly if you need outside
capital. Venture funding – the VCs, the angels, the banks – will not seriously
discuss things with you without at least a mini business plan. You have to
obtain the resources. My companies never have enough money and we
entrepreneurs never have enough time. These are the two biggest
commodities that I wish I had more of. We just finished raising $1.3 million
this week to get FDA approval for a medical device company. You need
resources such as capital, management, and sources of supply and
distribution.
Finally, we need to manage the enterprise. Can entrepreneurs become
managers? I think some can, some can’t. Sometimes entrepreneurs need to let
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professional managers help grow the company. The process is the same all
over the world.
A country needs ideas, money, and entrepreneurs. The last part of the
formula of why companies are created is the infrastructure in the country
itself. I have studied this all over the world. Here is a continuum between a
poor entrepreneurial culture and a strong entrepreneurial culture (see Table
3).
These are several reasons why one culture or an economy is more
entrepreneurial than another. One is ease in company formation. The easier it
is to form companies, the more companies are going to be formed.17 Just look
at the laws and the rules in countries regarding what entrepreneurs have to do
to form companies. Let us take three situations: forming a company in
Austria, in Russia, and in the United States. In the United States you can
form a company over the Internet with your credit card for about $200.18 In
Austria, it requires 13 governmental agencies, 10,000 Euros in the bank, and
2,000 Euros in cost.19 In Russia, it takes about one and a half years with
significant costs.20 Why is entrepreneurship so prevalent in the United
States? It is easier to become one.
Number two is the tax rate on businesses. When I was in Norway
speaking to a group of entrepreneurs and business people, the Minister of
Industry was there. She was not very happy when I said, “Why would you
bother to form a company in Norway? Do you know what your tax rate is?”
It is extremely high because the country wants a social net.
Same with the tax rate on individuals. If you tax businesses or
entrepreneurs heavily, why should they bother forming a company? If I am
going to work all the hours, take the risks, I want some kind of return. I want
to make some money, the second motivator. Countries need to monitor the
tax rate on companies and individuals. Generally, the higher the tax rates, the
less the entrepreneurial activity.21
17
E.g.,
Index
of
Economic
Freedom:
Belarus,
Heritage
Foundation,
http://www.heritage.org/index/country.cfm?id=Belarus (last visited Sept. 27, 2007) (stating
that burdensome regulations inhibit business in Belarus).
18
E.g., The Company Corporation, http://www.corporate.com/ (last visited Sept. 27,
2007).
19
See generally STARTING A BUSINESS IN AUSTRIA, SCHONHERR RECHTSANWÄLTE 5,
(Austrian Business Agency), available at http://www.aba.gv.at/en/pages/download.asp?file=
downloads/StartingBusiness.pdf.
20
See Establishing a Business in Russia: How to Set up and Register a Company in
Russia, Company Formations, Way to Russia http://www.waytorussia.net/business/
startingup.html (last visited Sept. 27, 2007).
21
See, Edmund Andrews, Paulson Says U.S. Hurt by High Tax Rates, N.Y. TIMES, Jul. 25,
2007, available at http://www.nytimes.com/2007/07/25/business/
25tax.html?_r=1&oref=slogin (demonstrating that high tax rates inhibiting economic growth
in US).
233
Bankruptcy laws and being able to let people go make a difference in the
amount of entrepreneurial activity. You know, in some countries, to fire
someone takes about a year. You go through numerous problems trying to
get someone off the payroll even if they haven’t performed.22 The better the
bankruptcy laws and the easier it is to hire and fire people,23 the more people
are going to become entrepreneurs in a particular country.
The extent of the infrastructure – such things as incubators, government
sponsored programs, government training programs, government providing
seed capital, and the government providing guaranteed loan programs – can
all help provide a positive infrastructure for entrepreneurship. These all affect
people forming companies. When all these are available, there is a solid
infrastructure for entrepreneurs to form companies.
Finally, there is the overall government attitude towards business and
entrepreneurship. Is it pro or not? We have gone through ups and downs of
government attitude in the United States, like other countries. The entire
atmosphere established by the government for entrepreneurs forming
businesses varies significantly across countries.
What makes things different in one country over another is not the people.
The people are very similar. They have the same motivations. They have
different demographics: more educated in some countries than others.
Obviously, there is a difference between the sexes forming companies in
various countries. However, the main differences are the atmosphere, the
culture, and infrastructure of the country in forming businesses.
Basically, it is the government’s responsibility to create the infrastructure
to support company creation. When looking at Canada and the United States,
the statistics were very interesting. In Table 4 there is information regarding
new firm formation and bankrupt firms from Canadian government material.
You will see that basically there has been an increasing formation rate over
the last five years in firms that employ more than one individual.24 If you add
the one-person firms, this number would double or maybe triple. In firms that
employ more than one individual, there was an increase from 19,500 up to
22
See
Index
of
Economic
Freedom:
Austria,
Heritage
Foundation,
http://www.heritage.org/index/country.cfm?id=Austria (last visited Sept. 27, 2007).
23
See Nathalie Martin, American Bankruptcy Laws Encouraging Risk-Taking and
Entrepreneurship, EJOURNAL U.S.A., http://usinfo.state.gov/journals/ites/0106/ijee/martin.htm
(last visited Sept. 27, 2007); Indepth: France – Student Protests, CBC News Online, Mar. 28,
2006, http://www.cbc.ca/news/background/france-studentprotests/ (stating that overly
burdensome labor laws restricting liberty to hire and fire has discouraged business in France).
24
See, BENJAMIN TAL, FOR LOVE OR MONEY? A STUDY OF ENTREPRENEURSHIP IN CANADA
(CIBC World Markets, Inc. 2005) available at http://www.cibc.com/ca/pdf/entrepreneurshipstudy.pdf; see also Study: Trends in Business Bankruptcies, Statistics Canada, Oct. 12, 2006
http://www.statcan.ca/Daily/English/061012/d061012c.htm.
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[Vol. 33 No. 1]
31,000 in 2005.25 Interestingly, in Canada bankruptcy has decreased26 down
to its lowest level, 25 percent, below its high in 2001.27 There were 787
bankrupt firms in 2005.28 Canada is really moving in the right direction –
increasing formation rates and decreasing bankruptcy rates.29 That’s a very
good sign.
Now, let’s look at the U.S. As is indicated in Table 5, the U.S. firm
formation is now rising again.30 Venture capital is increasing.31 The IPO
market is back.32 There will probably be double the number of high-tech
firms going public this year than last year, and new firms are being formed at
an accelerated rate. Again, if firms employing more than one individual
would be included, this number would triple.33
There were 671,000 firms formed in 2005. The U.S. is increasing its firm
formation rate as the economy has improved.34 Over the last three years firm
closures have stayed about the same.35 Remember, in the U.S. bankruptcy
means that the firm isn’t yet dead. The firm can come back out of bankruptcy
as occurred with Delta and Continental and other major corporations.36 The
25
See Hon. Maxime Bernier, Minister of Industry, Keynote Address for the Information
Technology Association of Canada in Ottawa, Canada (Feb. 6, 2007).
26
Statistics Canada, supra note 24.
27
Id.
28
See, TAL, supra note 24.
29
OFFICE OF THE SUPERINTENDENT OF BANKRUPTCY CANADA, INSOLVENCY IN CANADA IN
2006 (2007), available at http://strategis.ic.gc.ca/epic/site/bsf-osb.nsf/vwapj/Insolvency
Canada2006_E.pdf/$FILE/InsolvencyCanada2006_E.pdf.
30
RICH PERLINE, ROBERT AXTELL, & DANIEL TEITELBAUM, VOLATILITY AND ASYMMETRY
OF SMALL FIRM GROWTH RATES OVER INCREASING TIME FRAMES (SBA OFFICE OF ADVOCACY
2006), available at http://www.sba.gov/advo/research/rs285tot.pdf.
31
See example, PRICEWATERHOUSCOOPERS AND NATIONAL VENTURE CAPITAL
ASSOCIATION, Q2 2006 VENTURE CAPITAL INVESTING REACHES HIGHEST LEVEL SINCE 2002 AT
$6.3 BILLION (2006), available at http://nvca.org/pdf/MoneytreeQ22006.pdf.
32
Daisy Sarma, The Top 10 IPOs of 2006, THE MONEY TIMES, Jan. 2, 2007,
http://www.themoneytimes.com/articles/20070101/the_top_10_ipos_of_2006-id-102586.html.
33
See e.g., Robert Gavin, Going public has gotten better in Massachusetts, THE BOSTON
GLOBE, May 16, 2006, available at http://www.boston.com/business/globe/globe100/
Globe_100_2006/articles/going_public_has_gotten_better_in_massachusetts_ipo_growth_in_
05_nearly_doubled/; compare, Roy Harris, Maybe Next Year, CFO MAG., Oct. 1, 2005,
available at http://cfo.com/article.cfm/3220008?f=search.
34
SMALL BUSINESS ASSOCIATION, THE SMALL BUSINESS ECONOMY FOR DATA YEAR 2005,
A REPORT TO THE PRESIDENT 9 (United States Government Printing Office Dec. 2006),
available at http://leeds.colorado.edu/uploadedFiles/Faculty_and_Research/Research_Centers/
Business_Research_Division/sb_econ2006.pdf.
35
Frequently
Asked
Questions,
Small
Business
Association,
http://www.sba.gov/advo/stats/sbfaq.txt (citing the U.S. Department of Commerce) (last
visited Nov. 20, 2007).
36
Aude Lagorce & Padraic Cassidy, Delta Air Lines Exits Bankruptcy, MARKET WATCH,
Apr.
30,
2007,
http://www.marketwatch.com/news/story/delta-air-lines-emergesbankruptcy/story.aspx?guid=%7B13D92E05-7633-4376-B8E8-3EE20E25D790%7D; see also
235
U.S. had 544,000 bankrupt firm closures in 2005, which stayed constant for
the last three years. The number in bankruptcy was high in 2000 and 2001, as
you would expect, reflecting the bubble and the dot com problem.37
The interesting thing is that about the same number of firms form each
year as fail. Maybe a small net gain of 30,000 to 40,000 companies a year.
The failure rate is about 70 percent.38 This is not totally accurate, as firms
that form in the home and one-person companies are not tracked well. Only
in Slovenia are all companies tracked well, as there are only about one-and-ahalf million people in the country.
Basically, there is the same closure in terms of openings in the United
States with about 70 to 80 percent of companies failing over a five-year
period from startup.39 The U.S. forms a lot more companies than Canada and
will continue to do so.
The next table, Table 6, is World Bank statistics for Canada, China, the
European Union, India, South Africa, and the United States and how they are
doing in terms of entrepreneurship. First, the utility costs are very interesting.
It is cheaper to run a company in the United States in terms of utilities;40 only
China, India, and Africa are cheaper. So companies in the U.S. have an
advantage in terms of utility cost as well as basic construction costs. Canada
has a very high cost of getting into business and operating a business because
of construction and utility costs versus other countries in the world.41
You look at the percent in terms of contracts and how much it will cost to
get started; this measure by the World Bank is a percent of debt. Another
measure of the World Bank is the percent of debt. In the U.S., this is about
7.7 percent.42 Canada has a very high debt ratio in terms of attorney cost.43
The tax rate is also a key issue. In the United States, the tax rate is 46
percent on average because of the progressive tax rate.44 In Canada it is 43
Jennifer Bails, How One Airline Survived – Twice, PITTSBURGH TRIB.-REV., Oct, 10, 2004,
http://www.pittsburghlive.com/x/pittsburghtrib/s_260256.html.
37
Compare,
Bankruptcy
Statistics,
US
Courts,
http://www.uscourts.gov/bnkrpctystats/statistics.htm (last visited Nov. 20, 2007).
38
WILLIAM SHANKLIN, SIX TIMELESS MARKETING BLUNDERS 6 (Lexington Books 1998).
39
Adrienne Leigh, Buying a Franchise: Go Into Business for Yourself, Not by Yourself,
HOUS. BUS. J., Aug. 24, 2007, http://masshightech.bizjournals.com/masshightech/othercities/
houston/stories/2007/08/27/focus11.html?b=1188187200%5E1511128.
40
Dealing
with
Licenses,
The
World
Bank
Group,
(2007)
http://www.doingbusiness.org/ExploreTopics/DealingLicenses/, (showing that the U.S. spends
13.4% of its income per capita on construction and utility costs).
41
Id.
42
Enforcing
Contracts,
The
World
Bank
Group,
(2007),
http://www.doingbusiness.org/ExploreTopics/EnforcingContracts/. (U.S. is now at 9.4%).
43
Id. (showing that Canada is now at 16.2%).
44
Paying
Taxes,
The
World
Bank
Group,
(2007),
http://www.doingbusiness.org/ExploreTopics/PayingTaxes/.
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[Vol. 33 No. 1]
percent.45 Look at the tax rate in China, India, and Austria. These countries
place a tremendous tax burden on entrepreneurs setting up and running their
companies, 56 percent, 77 percent, and 81 percent, respectively.46
Finally, the World Bank has a very unique system of rating countries in
terms of starting a business and in terms of ease of doing business in 174
countries.47 Canada was ranked number one by the World Bank in terms of
starting a business, number one out of 174 countries.48 The U.S. was four.49
And in terms of doing business, Canada was four, and the U.S. was
three.50 In terms of the World Bank looking at countries being
entrepreneurial, the U.S. was in the top five, and Canada was number one in
the category of starting a business.51
As expected, it is more difficult in the European Union. Even though they
call themselves a union, they are not. It is different doing business in Austria
versus Germany versus Ireland. It is very different doing business there, with
Austria ranked 74.52 It is generally more difficult to start and operate
businesses in countries in the European Union.
China is extremely difficult, and I can vouch for that personally. India is
8853 and South Africa 57.54 You can see on a country-by-country
comparison, it is very different in forming and starting and operating a
business. What does this reflect? Mostly the infrastructure of the countries
previously discussed: tax rates, ease of company formation, bankruptcy laws,
government pro-business attitudes, incubators, guaranteed bank loans, or
even providing equity.
These make a difference on a country basis in terms of whether it is going
to be an entrepreneurial culture. In terms of entrepreneurship throughout the
world, there are several things needed.
You have to have the idea. You need to have money available,
particularly seed or startup capital, the most difficult capital to obtain.
You need to have entrepreneurs trained and willing and wanting to start
new companies. These potential entrepreneurs need to feel it is desirable, and
45
46
Id. (showing that Canada now has a total tax rate of 45.9).
Id. (showing that China now has a total tax rate of 73.9; India’s is 70.6; Austria’s is
54.6).
47
Economy
Rankings,
The
World
Bank
Group,
(2007)
http://www.doingbusiness.org/economyrankings/, (showing current rankings are from 1 –
174).
48
Id. (showing that now Canada is ranked as #2).
49
Id.
50
Id. (showing that Canada is now ranked #7, but the U.S. is still ranked #3).
51
WORLD BANK, DOING BUSINESS 2007: HOW TO REFORM 8 (2007), available at
http://www. doingbusiness.org /documents/DoingBusiness2007_FullReport.pdf .
52
Id. at 97.
53
Id. at 118.
54
Id. at 141.
237
possible. And you need the infrastructure available to start and operate
companies. When these four things are available, what happens?
One, ideas and creativity turn into businesses. While there are some
differences, with some nations being more creative than others, there is
creativity and ideas present in every country. The United States is very
innovative and creative. One thing I monitor is the number of patents filed by
U.S. versus non-U.S. citizens. Only one time in the last 20 years have more
patents been filed in the United States by foreigners than by U.S. citizens.55
As long as the U.S. continues to be innovative, I am not as worried about our
competitive position. As long as Canada and the United States remain
innovative, creative, and entrepreneurial, China can do what it wants to do.
Second, both countries need to have seed capital available. Again, in the
United States, there is a strong angel community, and they are now getting
into what is called bands of angels. I really don’t know how much impact this
will have because I think the real wealth will never get into a group. They
like to do things individually. But we will see what happens. There are bands
of angel groups operating in the United States today.56 There are two bands
in Arizona.57 On the other hand, there is little venture capital in Arizona. The
six venture capital firms are all fully funded, fully vested.
Third, entrepreneurs are more similar than different. They are like Mal
and myself. We are crazy and passionate. We love what we do, and we are
going to do it, no matter what it is. And finally, entrepreneurship varies
greatly reflecting the infrastructure, government attitudes, and culture of a
country.
That’s what makes the difference. You need to challenge your Canadian
government. We need to challenge the U.S. government. How are you going
to help build value? How are you going to stimulate and protect innovation?
How are you going to support taking technology to the marketplace by
entrepreneurs?
While I sent these slides in about three months ago, I did not know Mal
was going to use the same closing as I am – a Robert Frost poem. What is
55
See generally Rachel Konrad, Reverse Brain Drain Threatens U.S. Competitiveness,
Study
Says,
UNION
TRIB.,
Aug.
21,
2007,
available
at
http://www.signonsandiego.com/news/business/20070821-2102-reversebraindrain.html
(discussing the increasing number of U.S. patents filed by foreigners).
56
See generally JEFFREY SOHL, CTR. FOR VENTURE RESEARCH, THE ANGEL INVESTOR
MARKET IN 2006: THE ANGEL MARKET CONTINUES STEADY GROWTH (2006),
http://unhinfo.unh.edu/news/docs/2006angelmarketanalysis.pdf (overview of the angel
investor market in the United States).
57
See generally Arizona Angels, http://www.arizonaangels.com (last visited Sept. 26,
2007) (homepage for the Arizona Angels, an Arizona-based investment group); Desert
Angels, http://www.edesertangels.com (last visited Sept. 26, 2007) (homepage for the Desert
Angels, an Arizona-based investment group).
137
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[Vol. 33 No. 1]
particularly interesting in the poem are the last two stanzas. You look down
the road and you come to a fork. This is how Frost sets the stage in New
England, one of my favorite parts of the world. Frost concludes: I looked at
the fork – I knew I had a choice to take one branch or the other.58
We have all had what I call fork-in-the-road experiences. Look at your
life. There may be five, six fork decisions that radically affected your life
from then on. One of mine was going to Ireland in 1984. I spent eight months
living in a country helping impact its economy – an incredibly life-changing
experience.
Frost ends that poem saying: “I took the one (the fork) less traveled by,
and that has made all the difference.”59 That’s what entrepreneurs do. It is the
passion we have.
It is crazy, you know, to go through this process and finally make
something of it and think, “Why would I do that again?” Yet you go back
and do it again, again, and again. That’s how entrepreneurs are.
Thank you very much. You have been very attentive. I will be glad to
answer any questions.
DISCUSSION FOLLOWING THE REMARKS OF DR. ROBERT
HISRICH
MR. McILROY: We are into our Q and A session now, and we have 22
minutes. The floor is open. Who is first on deck?
DR. HISRICH: I was either very stimulating or very boring, one of the
two.
DR. BARBER: So far in our discussions here, we have been worrying
most about helping entrepreneurs, and you have ended up with a line, which
says our governments really need some help. How do you do that?
DR. HISRICH: That’s very hard. Starting companies is relatively easy
compared to that. I think there are several ways that we can assist
government in doing that. At least, I am trying to do that in Slovenia,
Hungary, and Russia.
It was said very nicely today before lunch, who contributes the net
employment? Who contributes the number of new products to the
marketplace? It is mostly the small business/entrepreneurial sector. I think
one thing we can do is help the government understand this sector’s
economic development.
What can you do to change the government and the rules and laws to
make people more interested in forming those companies? That is a long58
See ROBERT FROST, MOUNTAIN INTERVAL 75 (NEW YORK HENRY HOLD AND COMPANY
1999) (1920), http://www.bartleby.com/119/1.html.
59
Id.
239
term process, which I am working on in Slovenia and Hungary where there is
a lot of wealth to do this.60
How do I get wealth to invest, and how do I get the government to relax
some of the rules? One thing I came up with is forming a venture fund with
the government, matching each individual’s investment dollar for dollar, and
is giving 100 percent tax benefit for every dollar invested in this particular
fund, established to invest in entrepreneurs.61 Also, I am training people how
to evaluate businesses in which to invest; they are feeling more security
because they have other monies investing with them and they get a tax
benefit. It is important to make the laws more positive for investing and
entrepreneurial activity.
MR. McILROY: Daniel?
MR. SANDLER: One of the real difficulties in Canada and the United
States is that we live in federal jurisdictions, and there is competition
between states and provinces in Canada. And from a federal level, from a
country level, do you just have to live with the fact there are going to be
areas because we know entrepreneurs go into pockets, and that’s just the way
it will be, or is there enough to go around in all of the provinces and all of the
states to have some piece of the body?
DR. HISRICH: That’s a great question. I was asked that in Ireland in
1984 because they wanted to have a universal entrepreneurial society. I have
never seen a universal entrepreneurial society. I would like to tell you we can
do that but I have never seen it occur. I think what will happen is that there
will be these pockets of predominance in Canada as in the United States,
Ireland, Germany, and Austria. Austria will have one – Vienna.
And what do you do with any surplus money? We help these other areas
develop through other mechanisms. I just don’t think you are going to see
entrepreneurship throughout any country.
MR. McILROY: Dr. King has a question.
DR. KING: What do we have to worry about from the developing world?
In other words, who is catching up, and how can we protect our flanks?
DR. HISRICH: That’s a great question, Henry. I thought you said the
questions would be easy.
60
See The World Factbook: Hungary, CIA, http://www.cia.gov/library/publications/theworld-factbook/geos/hu.html (last visited Sept. 26, 2007) (complete profile of Hungary
including an economic overview); The World Factbook: Slovenia, CIA,
http://www.cia.gov/library/publications/the-world-factbook/geos/si.html (last visited Sept. 26,
2007) (complete profile of Slovenia including an economic overview).
61
See generally Raphael Amit, James Brander & Christoph Zott, Venture-Capital
Financing of Entrepreneurship: Theory, Empirical Evidence, and a Research Agenda (Draft:
Feb. 1, 1999), available at http://www-management.wharton.upenn.edu/amitresearch/docs/
VCfeb1.pdf (discusses venture funds financing entrepreneurial activity).
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MR. McILROY: That’s a love ball. That’s about as soft a question you
will get from Dr. King.
DR. HISRICH: Thank you, Henry.
Two of my books are in the Chinese language. My Entrepreneurship62
book sold over 200,000 copies in the Chinese language. A friend of mine
tells me that means it really sold 300,000. It still is not as bad as Iran where
this professor e-mailed me and said, “We love your book. We are not part of
the international copyright community. We are going to translate it. Would
you write a letter?”
I thought, “Let me see what you are asking me. Write a letter for you to
rip off my book, as I receive no royalty.” I waited a few days, wrote him
back saying, “I can’t write the letter, but I would love a couple copies of the
book when you publish it.” Six months later two copies of the Iranian edition
arrived.
Anyway, I am fortunate because that book and my Thirteen Biggest
Problems63 book are in Chinese. This has allowed me the opportunity to meet
top government officials. I will never forget, I was in Beijing a few years ago
with the president of one of the premier universities and we were at this
wonderful table he hosted; he has absolute impeccable English. For every
500,000 Chinese studying English, one American is studying Chinese. I
asked, “If you let people like myself into this country you are never going to
be the same.”
I had just lectured to thousands of students and entrepreneurs. My book is
being sold. I had been interviewed by 150 people from the media, print, radio
and television. He responded, “We know that. We also know we can’t
compete with the West with the economic situation the way it is; and we are
going to compete.”
So if I look around the world and ask who, ten years from today, are
going to be the economic powerhouses? China is going to be one. They are
powerful today and they will continue to be powerful in the future.
So if you look at a competitive threat, Henry, it is going to be China.
Some people say India but I just haven’t seen that. I have tried to do things in
India. India just has its ups and downs. Theoretically, they should be ahead
of China, but again, it’s the government, the infrastructure, and the attitudes
they have there.
62
See generally ROBERT D. HISRICH, MICHAEL P. PETERS, & DEAN A. SHEPARD,
ENTREPRENEURSHIP: Starting, Developing, and Managing a New Enterprise (McGraw-Hill
2007) (1989).
63
See generally ROBERT D. HISRICH, SMALL BUSINESS SOLUTIONS: HOW TO FIX AND
PREVENT THE THIRTEEN BIGGEST PROBLEMS THAT DERAIL BUSINESS (McGraw-Hill 2004).
241
I don’t see India becoming significant in the next few years. So it is going
to be from China. As Mal said he is competing with Chinese products that
are probably his design. China is here to stay.
MR. McILROY: We have a question at the back there, and then we have
a question at the right.
MR. KERESTER: Is there an optimum tax rate that would not discourage
entrepreneurship and still raise enough money for a business?
DR. HISRICH: Of course, zero.
MR. KERESTER: You really think that would contribute to it?
DR. HISRICH: No, not really. I am satisfied with the U.S. tax rate – but
will not quoted be on that.
I think entrepreneurs are literally fair-minded people, and we need to pay
to play. The problem is with a tax system that is unwieldy, when the
government gets more than you get, or gets above 50 percent, that is close to
the maximum.
While it bothers us to write tax checks, by the same token, we understand
the needs and infrastructure, and most entrepreneurs, interestingly enough,
give back. It is this giving back mentality they have, particularly in our two
countries where you make money and give it back.
Look at all the foundations in the U.S. that now take care of some of the
costs of the government, the museums, the art institutes, and things like what
Mal is doing here in Cleveland. Entrepreneurs give back. That reminds me,
in terms of Henry’s question, Chinese entrepreneurs know how to give back.
That’s very significant because that means they truly understand the entire
entrepreneurial model, making money, giving it back; their entrepreneurs
already have named buildings at Chinese universities.64 Nowhere in Europe
do you see that.65 You don’t see that in Japan.66 You don’t see that in
Australia.67
China is a force to be reckoned with. Does that help? I don’t know if the
right tax amount is 15 percent or 20 percent, but it has to be below 50, and
the lower it is the better. But a zero tax rate, I don’t think that would be that
beneficial.
MR. McILROY: Morris, we are just going to go to Brad Cherniak, and
then you are next.
64
See generally Alan Hunter, Centre for Peace and Reconciliation Studies, Coventry
University,
China:
Soft
Power
and
Cultural
Influence,
http://www.ipra2006.com/papers/CRPBC/ChinaSoftPowerAndCulturalInfluence.doc
(discussing the growing influence of Chinese entrepreneurs throughout China and the world).
65
Id.
66
Id.
67
Id.
139
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MR. CHERNIAK: With all that is going on in the world and in China and
the emerging opportunities, is it becoming harder or easier to become an
entrepreneur in America, say, ten years ago or 20 years ago than now?
DR. HISRICH: Do you take the hard questions?
MR. McILROY: No. I am just the moderator.
DR. HISRICH: You set me up for this, Henry. That’s a very interesting
question.
I don’t think it is any more difficult today than it was; it is a very
hypercompetitive world, but generally entrepreneurs are very competitive
creatures anyway, so that doesn’t bother us. In fact, I like it because that
means I have to be smarter, better, and faster than anybody else. I would
much rather have a competitive environment than a noncompetitive one.
When it really gets difficult for us is when there is not money available,
so the era of 2000 to 2004 was tough. I mean, entrepreneurs just couldn’t
find money and we need money. And, banks aren’t responsible for that
because they are asset based lenders.
The trouble is, as somebody said, we have no assets except for intellectual
property. Some ventures had no protection. So if money is available, then we
are fine; I don’t think it is any harder today. Today there is more money
available than ever in the history of the world. Today it is sort of fun to be an
entrepreneur.
I have had less trouble raising capital, and large public equity funds have
significant monies. Some people worry about them but I like them. My
companies are always up for sale. As long as we agree on valuation, you can
buy any of them. I think it is the same in Canada. I have never done business
in Canada except for my Boston Lens business and that was 20 years ago
when I was an MIT professor.
MR. McILROY: Morris?
MR. SHANKER: I want to follow up on Henry’s question. You suggested
ten years from now China will be a big player to be worried about, words to
that effect. Are you then suggesting the general prosperity of this country
will then be diminished if China becomes the big player or any other country
becomes the big player?
DR. HISRICH: I am sorry I didn’t respond succinctly enough because I
didn’t mean that. No, I think China is a dominant economic power that is
going to be here for the next decade.
The United States and Canada are fine. I don’t worry about China. In fact,
I think it is better to have another economic power. I don’t think our two
economies can carry the world any more. I think the world is too big and too
complicated.
So I find what they are doing – low cost manufacturing – is very
beneficial. I am a manufacturer, and I don’t consider that a threat. I consider
that a reality that they are going to be here as an economic power. I think our
243
prosperity is going to stay the same as long as we innovate and be
entrepreneurial. Our countries are in an entirely different product/market
space.
With about 80 percent of the economy of the U.S. in service-based
business, low cost manufacturing is not a threat.68 I would love to say
manufacturing is coming back, but I just don’t think it will at least, as we
now know manufacturing today. China is also a big market, too. Wait till the
people start making money over there.
MR. McILROY: We have another question I think from Daniel Sandler.
MR. SANDLER: I would like to come back to the angels, and they are the
key both in Canada and the United States. A number of things, there has been
a huge push in both countries to introduce a federal tax credit. It was deferred
by the SBA and seems to have died in committee or is dying in committee.
Do you think, first of all, that is a good thing, an income tax credit at the
federal level, and why do you think the governments are so adverse for that if
you think it is a good thing?
DR. HISRICH: That’s a great question. I never thought about that before.
I think people, entrepreneurs, some of them angels now, have accumulated
wealth through some means. I think some are going to be angels regardless
of the tax credit.
Even if you raise the tax a bit, I would still be an entrepreneur. I am not
sure it is going to stimulate any more investment. Maybe it would in Canada
– I don’t know your culture well enough. I don’t think it significantly would
in the United States.
Why do I think the governments of the two countries are not doing it? It is
the same in every government. I am trying to convince Slovenia they should
give 100 percent tax credit for these people to invest. The government
doesn’t like that. They want instantaneous money, not futuristic money. This
money won’t pay back anything until cash-out time, which may be seven to
ten years.
I don’t think governments in general are futuristic thinkers. Today it is
better to have today’s gratification rather than future gratification. However,
I am not a politician. Ireland was interesting. When I was there in 1984, the
Irish government tried to attract companies to manufacture there, feeling that
would be the salvation of country. That was the policy for years and there are
companies manufacturing there.69 The Irish government gave huge tax
68
Douglas G. Duncan, Jobs in a Changing American Economy, MORTGAGE BANKING,
June 1, 2004, at 2, available at http://www.allbusiness.com/personal-finance/real-estatemortgage-loans/170082-1.html.
69
See John Bradley & Jonathan Wright, Two Regional Economies in Ireland, 26 J. OF THE
STAT. & SOC. INQUIRY SOC’Y OF IRELAND 211, 218 (1993) (graph displays Ireland’s
manufacturing output on a steady rise throughout the 1980s), available at
http://www.tara.tcd.ie/bitstream/2262/2741/1/ jssisiVolXXVI211_276.pdf.
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incentives,70 and that didn’t really stimulate the economy.71 I am not sure
taxes are ever the main issue.
MR. McILROY: Maybe I could just follow on that topic. One figure that
really struck me, Bob, in your numbers was the number of firms that were
formed in 2005 in comparison between Canada and the United States.
Usually in Canada, there is the ten times rule.72 Our population has been
generally one tenth of yours, so we usually expect to see a number in the
U.S. to be ten times what it is in Canada.
But in 2005, 30,000 new firms in Canada roughly;73 the United States,
672,000.74 So in other words, it was 20 times instead of ten times, and I see
that as twice as high per capita, which is a significant difference. That sort of
flies in the face, I think, of the World Bank numbers where they sort of seem
to say we were the same.
I, as a Canadian, think that there are far fewer entrepreneurial firms
formed in Canada, and your numbers seem to hold that out.75 The World
Bank numbers, I am not so sure, and I was wondering if you could comment
on that, why you see more firms formed in the United States and more of an
entrepreneurial spirit?
DR. HISRICH: Good question. These numbers came right from the
government numbers. Remember these numbers reflect people that form a
company and have at least one employee, not a single employee firm. That
would really change these numbers if we add single employee firm
formations. I think it will probably change the numbers equally in both
countries.
The numbers would at least double. The U.S. has always had a culture
(and I don’t know Canada well enough except my experience in Canada with
70
See Kevin H. O’Rourke, Industrial Policy, Employment Policy and the Non-Traded
Sector, 27 J. OF THE STAT. & SOC. INQUIRY SOC’Y OF IRELAND 61, 67 (1994) (“[W]hile
manufacturing and traded-sector service companies pay 10 per cent corporation tax, firms in
the non-traded services sector pay a 38 per cent rate.”), available at
http://www.tara.tcd.ie/bitstream/2262/2104/1/jssisiVolXXVII_6192.pdf.
71
See Bradley & Wright, supra note 69, at 228 (graph displays an increase in Ireland’s
unemployment numbers throughout the 1980s).
72
See Lukin Robinson, Book Note, MONTHLY REV., April 1999 at 1 (reviewing JOSEPH K.
ROBERTS, IN THE SHADOW OF EMPIRE: CANADA FOR AMERICANS (1998)) (“In population,
income and wealth, Canada is about one-tenth the size of the United States.”), available at
http://findarticles.com/p/articles/mi_m1132/ is_11_50/ai_54517447.
73
See generally Geoff Lewis, Who in the World is Entrepreneurial, CNN Money, June 1,
2007,
http://money.cnn.com/magazines/fsb/fsb_archive/2007/06/01/100049637/index.htm
(discusses the ease of starting a new business in various countries including the United States
and Canada).
74
Id.
75
Id.
245
my Boston lens) forming things, being creative, and being our own boss. And
we have this angel environment that makes money available.76
We have taught entrepreneurship in our schools a lot longer than Canada.
Remember, teachers do have an impact.77 This started in Canada at the
university level about six years later than the U.S.78 It started rigorously in
the U.S. in about 1980.79 Germany just started teaching entrepreneurship in
their schools two years ago.80
So educationally, we have been more prone to create entrepreneurs, and
our society is probably more open and supportive of entrepreneurs. It is just
the culture that the U.S. has had throughout, which perhaps hasn’t been quite
as strong in Canada.
By the same token, the World Bank is talking about their overall
measurement, so these are their rankings. The numbers in the United States
and Canada versus other countries make relative sense to me.
MR. McILROY: I understand we are down to two minutes, but Henry has
just given me the you-are-out-of-time sign. So I think we are going to call
this to a close.
I would like to very much thank Dr. Hisrich for traveling from Arizona to
join us. I think we can all agree that he brings a unique perspective to the
topic of this Conference, and I would like you to join me in thanking him for
his presentation.
76
See generally THE NATIONAL ASSOCIATION OF SEED AND VENTURE FUNDS ET AL., SEED
VENTURE CAPITAL: STATE EXPERIENCE AND OPTIONS MAY 2006 1-4 (2006),
http://www.nasvf.org/web/nasvfinf.nsf/
pages/svcp.html/$file/Seed%20and%20Venture%20Capital%20Report%20-%20Final.pdf
(discusses history and current state of the venture capital market).
77
See generally Lena Lee, Entrepreneurship Education – A Compendium of Related Issues
(NUS Entrepreneurship Centre, Working Paper No. WP2005-14, 2005), available at
http://unpan1.un.org/intradoc/groups/public/documents/APCITY/UNPAN023986.pdf
(discussing the recent trend of entrepreneurship being taught in universities worldwide).
78
Id.
79
Id.
80
Id.
AND
141
INTELLECTUAL PROPERTY ASPECTS OF
ENTREPRENEURSHIP: PROTECTION IN PATENT AND
TRADEMARK AREAS, AS WELL AS COPYRIGHT AND KNOWHOW AREAS (LOCAL AND FOREIGN); PENETRATION OF
OVERSEAS MARKETS (DIRECTLY OR THROUGH
LICENSING); POSSIBLE INDUSTRIAL ESPIONAGE CONCERNS
Session Chair – Raymond Ku
Canadian Speaker – James Longwell
United States Speaker – Diane H. Dobrea
INTRODUCTION
Raymond Ku
DR. KING: Okay. We are ready. Let’s go.
PROFESSOR KU: Welcome back, everyone. I am Raymond Ku. I teach
Copyright and Constitutional law here at Case Western. I am also co-director
for the Center for Law Technology and the Arts, which is why Henry asked
me to chair our panel here on intellectual property aspects of
entrepreneurship. I won’t give you the boring summary of what the criteria
for copyright, trademark, and patent law is. I will just tell you that,
obviously, from the perspective of entrepreneurs, intellectual property is
often viewed as having the attributes of a double-edged sword.
I think it is billed as a friend in the sense that it provides, often, the
necessary incentive and the legal protection for entrepreneurs to actually
make the investments that they do and engage in the business activities that
they do. But it can also be an incredible barrier to entry. Just look at any
newspaper today. The fight over patent law, copyright or trademark as
intellectual property has expanded beyond the more traditional common law
origins into, maybe, the respective regulatory regime. It can be quite difficult
for entrepreneurs to navigate the regulatory waters.
We are fortunate to have our two distinguished panelists here with us
today. They, unlike myself, come on the harder side of intellectual property.
They are both attorneys and patent law experts. James Longwell, directly to
my left, is partner at Gowling Lafleur Henderson in Canada where he
specializes in information technology law, especially in the patent aspects of
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that field. Further to my left is Diane Dobrea, a partner at Calfee, Halter &
Griswold in Columbus, Ohio. She, again, is, as I said, a patent attorney
whose primary focus is biotechnology law. And one brief note about Diane,
she is also a graduate of Case Western Reserve University and an adjunct
professor in our Center for Law Technology and the Arts.
Now we are going to adopt the format used by the venture capitalist panel
earlier, and we will kind of leave it as a free form discussion both among the
panelists and you in the audience.
Longwell & Dobrea—Intellectual Property Aspects of Entrepreneurship
249
Diane H. Dobrea∗
&
CANADIAN SPEAKER
James Longwell∗
MS. DOBREA: Okay. Well, I will pop in first and say thank you, thank
you, Professor King, for inviting me here. I am actually a three-time alumnus
of this university: undergrad, grad in biochemistry, and law.
DR. KING: Can you all hear Diane?
∗
Diane Dobrea is a partner in the Columbus office of the law firm Calfee, Halter &
Griswold LLP. She practices in the area of intellectual property law, with a combined focus on
intellectual property transactions, and preparation, prosecution and maintenance of patent and
trademark cases. Though her technical background is in biotechnology, Ms. Dobrea’s patent
practice also includes nanotechnology, chemical, medical device, and consumer product
portfolios. Ms. Dobrea overseas several large patent and trademark portfolios, working
extensively with associates at law firms around the world on all aspects of intellectual property
management. Serving both for-profit and not-for-profit entities, Ms. Dobrea provides due
diligence and freedom to operate analyses, counsels clients on a wide range of research and
intellectual property related transactions, and assists in litigation and dispute resolution
concerning intellectual property. Along with her law degree, Ms. Dobrea also received her
undergraduate and masters degree in Biochemistry from Case. She is a member of numerous
Bar and Intellectual Property Law Associations and the Association of University Technology
Managers, and has been an adjunct professor in Biotechnology Law and Policy at Case’s Law
School. Prior to joining Calfee, Ms. Dobrea served in the offices of the general counsel and
technology transfer at the Cleveland Clinic and in the technology management office of
Case’s medical school.
∗
Mr. Longwell practices in all areas of intellectual property law, particularly as it applies
to computer and information technologies. He advises start-up companies, small businesses,
universities and large corporations on intellectual property strategy, including acquisition,
protection, exploitation and enforcement issues. Mr. Longwell is also involved in Canadian
and foreign patent and trade mark agency, primarily preparing and prosecuting patent
applications relating to computer software, hardware, enterprise computing, web development,
telecommunications, medical devices, housewares and business methods. Mr. Longwell also
provides strategic analysis and advice to business owners and investors for financing, joint
ventures, technology procurements, development and commercialization transactions.
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MS. DOBREA: It is just always a pleasure to come back to the
University. Although I relocated a year ago down to Columbus with our law
firm, I find my way up here a lot, so I am used to seeing the faces around
here on the campus.
We are trying to be responsive to the sentiments and questions that have
been raised over the last couple of days in terms of how IP factors into the
entrepreneurial context. And I say entrepreneurial context because there have
been a lot of conversations about entrepreneurs and individuals or a small
team starting up and taking an innovation out into the marketplace. But from
the standpoint of an IP attorney, we deal with entrepreneurs whether they are
a business unit within an existing company that is trying to go after a new
opportunity or an individual who has a concept and wants to figure out how
the solution that he or she has found can also make it out in the marketplace
to help other people be successful and maybe make some money, too.
That is the backdrop of how we deal with intellectual property. What we
want to talk about today is the role of intellectual property in the
entrepreneurial context in terms of making decisions about when to spend the
money, when to spend the time to figure out what kind of real estate you
have got to protect, and whether or not you are stepping on someone else’s
real estate – which is an important consideration that can’t be overlooked.
Also, what is your competitive strategy and how, if at all, does IP fit into that
competitive strategy?
There certainly have been a number of people who have recognized that
you can have an innovation that isn’t capable of being protected by IP, at
least in terms of patent and trade secrets. So what other IP vehicles are
available, and how can they best be exploited, and what are the risks
associated with going forward with those things or protection?
Just quickly, when we do our due diligence we are really looking at two
components: What does the entrepreneur have that can be protected and how
do you figure out how to capture that.1
But equally important, when that entrepreneur goes out into the
marketplace with their innovation, what do they have to deal with in terms of
somebody else who is already there? What ability do those other entities
have to stop them from being productive? The bottom line is education is
expensive and ignorance can cost more.
And I think that’s definitely true. We, as IP attorneys, like to have all of
the information at the earliest point in time so that we can pick it all apart and
1
See generally William J. Murphy, Proposal for a Centralized and Integrated Registry
for Security Interests in Intellectual Property, Appendix 6: Due Diligence, 41 IDEA 445, 446
(2002) (“Due diligence involves the investigation to verify and establish the existence of the
intellectual property asset and liability and to determine the extent of encumbrances or
restrictions on the rights to use the property.”).
251
give you your best strategy. The reality is that the costs of us doing that are
often so prohibitive that the best that an entrepreneur can do is understand
enough about the context of the market they are going into to be able to
weigh spending the money up front versus waiting and seeing what happens
down the road.
We will then transition into covering how you protect your IP and talking
a little bit about the differences on a global basis and certainly the differences
in our IP schemes in the U.S. versus Canada.
MR. LONGWELL: I have been asked to focus more on the role and
relevance of IP in the entrepreneurial context, and I think there are a lot of
different facets to it that people tend to concentrate on, but there are many
things they don’t examine.
As Raymond mentioned at the beginning, I look at IP as both a friend and
a foe. It is a friend, certainly, insofar as it attracts capital, which is really
what every entrepreneur is chasing. IP doesn’t follow money; money follows
IP. It really brings in the money if it is there.
Why? Well, it is a vehicle that you can use to crystallize the knowledge
that the inventor has, into a property right, which then can be held by a
specific entity. Then those property rights endure for a certain life, usually 20
years for patents, longer for trademarks and so forth, but they are going to
outlive that entrepreneur. So when the entrepreneur becomes disgruntled and
wants to leave, the IP stays behind and continues to grow within another
entity.
Most people see the acquisition of exclusive rights as the ultimate goal of
IP. That’s what the IP is supposed to be bringing to them. That’s certainly
one of the aspects. Sometimes they lose sight of what that really means.
An exclusive right might be great for trademark. I can use my trademark
and I have a right to do so. But for patents, it is not always that way. It is a
patent right and that gives you a right to stop others from making or using the
invention that is claimed there.2 But this is not a right that you can use.3 It
does not give you that opportunity.
It is subject to the third-party right of others that we talked about. You
know what else you can do with the exclusive rights? Well, you can copy
them yourself or enforce them, but obviously, there is a vehicle you can use
to license to others. You can get other people involved. So we excite people
2
See 35 U.S.C.A. § 154(a)(1) (West 2002).
See id; See also Little Mule Corp. v. Lug All Co., 254 F.2d 268, 273 (5th Cir. 1958)
(“[A] patent is not the granting of a right to make, use or sell.”); see also Crown Die & Tool
Co. v. Nye Tool & Machine Works, 261 U.S. 24, 36 (1923) (“The government is not granting
the common-law right to make, use and vend, but it is granting the incident of exclusive
ownership of that common-law right.”).
3
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and are able to offer things within intellectual property, and you can work
within your own market.
But look forward, where might you be ten years from now and who might
be there to help you? Go to Europe. File a patent application. Secure rights in
China. Maybe you will be licensing other partners to get you into that market
sooner.
Then, of course, in the last few years of development, that intellectual
property itself can be relegated to someone else. People don’t want to
practice. They don’t want to go into the marketplace. Many are happy to own
IT and sit back and wait for someone else to stumble upon it so that they can
be that troll who jumps out from under the bridge and says, “Ha, ha, I need a
toll for you to pass over.” It is going to cost you a lot of money. Our
experience with our neighbors in Waterloo for Research In Motion – it cost
them a lot of money to pass over that bridge.
So, that’s one of the attractive aspects if you are one of these people, but
it is one of the foe aspects for new entrepreneurs coming into a new space.
They have to be worried about the third-party IP that can be shaping the
scope of the protection for whatever they wish to obtain as well as just being
a barrier to entry into a particular market.
So that, of course, involves a due diligence exercise. We are going to talk
a little bit about that in a few moments. How do you evaluate the rights of
others when you want to take the IP? When do you want to take the
opportunity to do that? Is that something you do earlier? Do you postpone
that if you can? How much money are you going to spend, and in what
markets are you going to do that because it can be a very costly exercise?
And why is it costly?
Well, IP is complicated. I mean, it is science law, and the law puts you in
institutions, and as much as we heard the money doesn’t like to see borders.
IP lives and dies, in a way, on borders and the nuances and the various laws.
It is really important that when we see new entrepreneurs coming in, maybe
the institutional context like universities where they had this great idea, they
did their thesis, they had it published, everything looked great, and somebody
told them that they should commercialize. They got some interest, and then
they realize their entitlement has been lost in jurisdictions because they
published first. They are no longer able to secure the adequate protection
they thought they could get there. So borders exist.
The differences in law are very much apparent in intellectual property. It
is costly because, well, we charge more for professional services. There are
fees involved. You are moving into foreign markets whose translation costs
are involved, and that’s up, but also, we deal with hard data.
There are lots of opportunities where there is nothing you can do to
extend it, and that’s time and effort for entrepreneurs and innovators to take
253
out of what would otherwise be conducting their business to handle these
issues and that can be costly.
The next thing, before we go on, I want to address the educational deficit
that entrepreneurs often have in regards to their role in the IP and how IP is
used. They are not really sure of the different types of rights available to
them, the confusing copyright, for example, and patent rights, copyright and
trademarks, for example.
So when they are engaging with others to do the types of work that they
would normally do on their own, they are not setting themselves up to best
protect their own innovation. So we have to spend a lot of time with them
putting into place these proper procedures – the employment contracts, the
ways that they can capture their innovation so they are protected going
forward, to prove ventureship and other ownership issues. Those are big
aspects to entrepreneurs looking for a gain with the lowest cost.
That has lasted awhile, and our institutional innovators, in particular, are
facing increasing pressures to both innovate as well as to attempt to protect.
And costs on the outside are very hard, tough to absorb, and we need, as
professionals, to find ways that we can assist these institutional innovators to
bring our costs into their budgets, educate them as to why we can’t always do
that. So we have to be careful to navigate IP policy issues with inventors and
add a level of complexity that is costly.
MS. DOBREA: By the way, we are welcoming any kinds of questions so
don’t hesitate to interrupt.
But going off those comments, patent law is clearly very complex. It can
be complex based on the kind of IP that you seek to protect, and the extent
and quality, completeness of the disclosure especially in the research context.
Those of us who work with university inventors know that they have great
ideas that are developing, and they are going to be out there publishing.
There is a big push in those institutions to protect transfer functions and take
those ideas and get them to market.
What they lack in those organizations is the sophistication in a particular
business area. So, you have got tech-transfer people handling technologies
that span these very broad ranges.4 And that’s not even to mention the
political dimension within an organization and who really calls the shots in
terms of how technology is taken out to the marketplace.5
4
See generally University Technology Transfer: Questions and Answers – The Council
on Governmental Relations, http://www.cogr.edu/docs/BayhDoleQA.htm (last visited, Nov.
13, 2007) (noting the “broad spectrum of organizations and individuals” to which universities
license technology); see generally Jeff Karoub, Industry experts shed light on technology
transfer,
SMALL
TIMES,
Nov.
29,
2004,
available
at
http://www.smalltimes.com/Articles/Article_Display.cfm?ARTICLE_ID=269746&p=109
(discussing the use of industry consultants during technology transfers).
5
See generally Karoub, supra note 4 (discussing the internal conflicts universities face
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DR. KING: Are you going to cover the competitive law aspects?
MS. DOBREA: Yes.
DR. KING: I was thinking about that troll under the bridge. I think it is a
major concern in some cases, in both the United States and Canada. You
could do it now or whenever you want to do it.
MS. DOBREA: Okay.
MR. ROBINSON: Following up on the comment about the university
inventors, in my experience, it has been troublesome to do high-tech joint
ventures with university people who were also affiliated with a private
research institute. There was one connected with a hospital, and I understand
that is very common, certainly here at the Cleveland Clinic.
The big problem was to figure out when the guy had his great insight.
Was it while shaving in the morning? If so, was he was doing that for the
university or the hospital? And, of course, my client was a bloody-minded
commercial corporation who was going to grab this technology and do huge
IPOs and make jillions of dollars. It was just a disaster.
We couldn’t sort the thing out properly. I understand that in the U.S. there
is a law or protocol that makes it clear how much of an ownership stake the
university has in the innovations of its professors, and how much stake a
professor has in the same.6 Alternatively, I suppose a professor may be able
to avoid this issue altogether by saying, “I did that for the private research
institute.” This is what the commercialization person wants to deal with.
So I guess the question is: is there such a law, and is there any way to deal
with this in Canada, where there doesn’t appear to be one?
MS. DOBREA: No such law exists. Maybe what you are thinking about is
the Bayh-Dole Act. The Act can apply if there is federal funding in an
institution. It can also apply in the context of a company that works under an
SBPR grant, a small business type grant that focuses on driving innovation
and has basically a feed into provisions that are equivalent to Bayh-Dole.7
Bayh-Dole doesn’t prescribe the numbers for sharing. But Bayh-Dole
does prescribe some fundamental concepts that the Government, by funding
all or a portion of whatever work is done like innovation, has the right to
have a disclosure of innovation. It also has some expectations of the
university that wishes to elect title because the Government owns it in the
first instance, so the institution has to elect title.8 I mean there is a
straightforward procedure and there is the underlying power of issues.
when dealing with technology transfers).
6
See generally 35 U.S.C.A. § 202 (West 2002) (noting the disposition of rights of each
party to a funding agreement).
7
See 35 U.S.C.A. ch. 18 (West 2002).
8
Id.; see also Council on Governmental Relations, Intellectual Property and Technology
Transfer: the Bayh-Dole Act: A Guide to the Law and Implementing Regulations,
255
The procedures are relatively simple to execute. Compliance is spotty.9
You know, it just depends on how well situated an institution is to really
capture and administer those steps. But at the end of the day, you know, they
have identified the IP. They have notified the Government. They have
elected title. They have granted back the confirmatory license to the
Government so the Government can itself, on its behalf, have that technology
factor.
The institution is expected to favor small businesses over larger ones.
That’s not an absolute. Favoring U.S. businesses over foreign ones is also not
an absolute. Still, for a substantial manufacturer in the United States that is
pretty big, getting over that hurdle is not the easiest. The Government
reserves march-in rights.10 So if compliance is not good with respect to
making the best effort to get the technology, that taxpayers paid for, into the
marketplace then the Government could conceivably march in, take those
rights over, and hand them over to someone else.11
There have been a few forays into trying to get a federal agency to
exercise march-in rights, but that hasn’t really happened. So it looks onerous,
but it really hasn’t operated as such. One component of that is that a share of
the revenue that comes back to the institution goes to the inventors. But what
percentage is ultimately prescribed by that institution’s policies? There are
no guidelines, but pretty much across the board, it is a decent share at most of
the institutions that I am familiar with.12 There have been surveys done by
the Association of University Technology Managers and Licensing
Executives to support that.13 They are two organizations that track innovation
particularly out of funding institutions.14 But if you are outside of the federal
funding context, then it is sort of a free for all.
At most, it is up to the policies of that institution, and you have by then
identified one of the important issues that can be a problem down the road.
http://www.mtsu.edu/~research/docs/TheBayh-DoleAct.pdf (last visited Oct 21, 2007).
9
See U.S. General Accounting Office, Technology Transfer Reporting Requirements for
Federally Sponsored Inventions Need Revision, GAO/RCED-99-242 (Aug. 1999), at 2,
available at http://www.gao.gov/archive/1999/rc99242.pdf.
10
Id at 5.
11
Id.
12
See generally The Association of University Technology Managers: Frequently Asked
Questions, http://www.autm.net/aboutTT/aboutTT_faqs.cfm#7 (last visited Oct. 22, 2007)
(discussing how universities use the revenues realized from licensing).
13
See The Association of University Technology Managers: Licensing Surveys,
http://www.autm.net/about/dsp.licensing_surveys.cfm (last visited Oct. 22, 2007) (full surveys
available for purchase).
14
See The Association of University Technology Managers: About AUTM,
http://www.autm.net/about/ (last visited Oct. 22, 2007); see also Licensing Executives Society
International: About LESI, http://www.lesi.org/content/presidentsmessage.aspx#what (last
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Do the due diligence at some early point to determine under what context an
invention arose. Even if we are talking about an entrepreneur not associated
with the university, you would be surprised to find out what their friends are
working on. “Oh, yeah, this guy was a consultant, but he was actually a
doctor of this hospital. And his contract stated that anything that he invents
has to be assigned to the institution, even if he signed an agreement to the
contrary.”
So sometimes you have to dig far enough to understand all the
connections in order to identify what could be a problem. And it is a matter
of when do you do that digging, because at some point you might be down
the road trying to unload that technology per your exit strategy, and you
don’t want to find out then, when they do their due diligence, that you don’t
have claim to title.
Then you have somebody that says, “Sure, I would be happy to assign it
for whatever.” But that’s only one piece of it; identifying who are the rightful
contributors, if there is an inventor, if there is a problem with somebody who
claims to be an inventor, which would upset the validity of a patent down the
road.
So it might not be something that is going to rear its ugly head for ten
years after the entrepreneur started the company and got it going. When do
you look at those issues, and how do you deal with them is a difficult
question. Generally, it can certainly vary between the United States and
Canada. I am absolutely certain in the United States that, except for an
employment contract that someone may have or the Bayh-Dole Act that may
impose certain obligations on a funded investigator, if somebody works for a
company and comes up with an investigation there is no agreement that says
they are obliged to assign that to the company, that they own it as an
inventor.15
And there are plenty of relatively sophisticated, and in some instances
large, clients that I dealt with who maybe know that and talked to some of
the organizations. But they will do anything to implement it. They are really
surprised, sometimes, when that really nice engineer says, “Yeah, I would be
happy to assign it to you. I want my X amount of dollars or a percentage.”
Then the client calls up and says, “They can’t do that. It is work for hire.”
“No, that doesn’t apply in the context of an invention whereas…”
MR. LONGWELL: Whereas in Canada, we generally have the rule that,
if it is not in the employment contract, if you were hired to invent, it will be
15
See National Development Co. v. Gray, 316 Mass. 240, 246, 55 N.E.2d 783, 786-787
(1944) (“[The Court] looks upon an invention as the property of the one who conceived,
developed and perfected it, and establishes, protects and enforces the inventor’s rights in his
invention unless he has contracted away those rights.”).
257
implied that your invention is owned by your employer.16 So that is a
remarkable difference between our two countries.
MS. DOBREA: So then it doesn’t matter whether they say I am or am not
an inventor if somebody asserts inventorship later and tries to upset the apple
cart later.
MR. LONGWELL: Absolutely, as well as the misnaming in the patent,
minimizes so the courts aren’t quite so concerned. As long as they were up in
the listing, the applicant was the one who was really entitled, whether they
got the inventor’s name correct or not is not a major concern. It can be costly
to throw out the issues and get a ruling that, in fact, the invention claimed by
the inventor, it doesn’t really upset the apple cart, then so be it.
But to go back to Dr. King’s question, we will talk a little bit more about
IP strategy later, but there is a real difference I think in the culture in Canada
and the litigation area and our laws in that area that have made trolls far more
attractive in the U.S. context than they are in Canada. There are a number of
reasons for that. One of them is the cost of litigation in Canada.
Successful parties are entitled to costs, and you can lose and still be
entitled to costs by making proper settlement offers. We don’t have jury trials
in Canada in patent matters. They are almost exclusively really big trials and
are all settled by federal court judges who have some expertise in this area.17
So again, there is no big award at the end of the day. We talked a little bit,
Diane and I, about the differences of triple damage awards that are available
here for people who acted out of willfulness when infringing. You don’t have
any of that opportunity.
So with a smaller market, with those big litigation differences, we don’t
have a troll issue, per se, in Canada. We have IP rights holders. We have
universities, institutions that hold IP and don’t exploit them, and they are
troll-like in a way. They are ready to license, but they are not viewed with the
same disrespect that private individuals or corporations, limited liabilities are
when holding on to these IP rights and exploiting them. At the last moment.
And, really, is that a problem with patents, or is it more a question of
litigation culture? Maybe there is an inability there.
MR. McINTOSH: Just following up on Michael Robinson’s question, I
was interested in knowing if in Canada, if a business decides to work along
with the university and enters into an arrangement with the university in
essentially a work-for-hire type of contract, where the business has an idea,
then goes to the university to make arrangements for that idea to be
developed into a prototype – are there special concerns that need to be
16
Colleen Spring Zimmerman & Ziad J. Katul, Patent Ownership in Canada, THE LAW.
WKLY., Apr. 21, 2006.
17
Rudolf E. Hutz, Where To Litigate Patent Infringement Cases, 1 DEL. L. WKLY. n.4
(Dec. 1, 1998).
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addressed in terms of making sure that the intellectual property is conveyed
to a business that would be outside the normal course of a contract, saying
this is work-for-hire, or is the university free to enter into those kinds of
relationships in order to basically provide opportunities for their students?
MR. LONGWELL: Well, that’s a good question, and I think you get
different answers from different universities. I can use McMaster University
as an example. Their IP policy would dictate that the university is supposed
to benefit in these situations. They would allow professors to have ownership
rights, but this doesn’t mean they won’t be able to come to an arrangement
with the person in part of the trade or even other parties who might be paying
a portion of that.
So that at the end of the day, the business owns what it needs to own to
make sure it is exploited in a commercial manner. Universities are getting
some credit getting their license back, and this is useful. Then you have
another institution down the road where RIM is in Waterloo. The University
of Waterloo’s IP policy states that, as inventors, you own 100 percent, and
we would love it if you would think of us when you are successful, to give us
something in return. This is a very pro-inventor and pro-entrepreneur culture.
It depends who you are. Some institutions are a little more inflexible, and
they retain ownership. They want their name on the IP. They think it is a barn
and that can be difficult because of Canada’s co-ownership law on patents.18
It is very much more complicated than the United States.
MR. COHEN: This is off the topic but in line with the world of
globalization, at what point do I file all of these foreign patents? Do you have
a timeline chart covering this?
MS. DOBREA: Well, much of it is hardwired into the way the whole
system works, except if you are outside of the treaty countries, which, you
know, carry the wisdom of filing in a lot of those countries because of the
market size and the great unpredictability of what you are going to encounter
in their patent offices.
There are a couple of different levels on which to answer that question,
but if the simple question is: what do I predict as my timeline once I file an
application? It is pretty much etched in stone. With respect to what’s within
the four corners of a patent application, it is filed as your priority application.
Whether you file a U.S. provision or U.S. utility or file first in the Patent
Cooperation Treaty (PCT), which is sort of a central place where you can file
and get into all the treaty countries or file first in Canada, one way or the
other, you have gotten yourself into the patent system.19
18
Francois Painchaud et al., International Mergers & Acquisitions: The Canadian
Perspective, http://robic.ca/publications/Pdf/277-FP.pdf (last visited, Oct. 22, 2007).
19
See generally Sheldon Mak Rose & Anderson, First-to-File v. First-to-Invent: A Bone of
Contention
in
the
International
Harmonization
of
U.S.
Patent
Law,
259
And with respect to all the countries that are party to the Harris
Convention and/or under the PCT, you are in the system. You can’t change
that application.20 You can’t add any new matter, which means you better
hope you completed disclosure as you need, and that means to get the kind of
claims you would like to get.
Twelve months out is usually the time frame where you have to jump off
and get into the national, the PCT filing, the international filing and then
depending on the jurisdiction, 30 months from the priority filing date, so
that’s the priority filing date. That’s the provisional date.
That was your first application, which is when you have to make the first
decision about jumping off into the various national jurisdictions you want it
filed in. So it is hardwired, and that can be good or bad. If you have got no
prior disclosure of your invention, forget right now about freedom to operate,
but you have your invention captured, completely enabled in your disclosure,
and if you have the opportunity to have some substantive examination within
that initial 18 to 30-month period, then you are in the best position to make
decisions about the viability of the kind of claims you would want to get in
the jurisdictions that from a business standpoint you want to get perfection
in. I am not sure if that’s responsive to you.
MR. COHEN: That’s pretty responsive.
MS. DOBREA: From the nuts and bolts standpoint, that’s the easy
answer. The harder answer is when do you first file, and that brings us into,
under due diligence, what we were first talking about, when do you even try
to figure out if what you’ve got can be protected? From a patent attorney’s
standpoint, I am certainly surprised at the timing of when entrepreneurs try to
actually answer that question.
I say I am surprised because they will, a fairly long distance out, get a lot
of their own money committed, friends and families’ money committed,
perhaps angel money committed, writing business plans, getting toilet pipes
made, getting engineers doing things for them, and then they say let’s sit
down and talk to patent counsel.
And I laughed at that because sometimes you give them answers that they
don’t want in view of how much resource they already put into it. But we
heard a good example yesterday about flying completely blind. The inventor,
though, wasn’t going to tell what was inside the black box; didn’t want
anyone to look, and on faith, the investors went forward, and that hydrogen
peroxide sterilization technology is going to be a reality in the marketplace.
So presumably at some point, they got their heads around what there was
to protect, and they also figured out whether or not they are going to step on
http://www.usip.com/articles/1st2fil.htm (last visited, Oct. 22, 2007).
20
See generally Garry E. Hunter, Status of Intellectual Property Law in the Age of the
Internet, 38 L. TECH. 1, Jan. 1, 2005.
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someone’s toes and, at a minimum, have a lot of their money spent defending
an infringement suit and potentially be knocked out of the market.
So that kind of timing, that’s a little bit tougher to sort out, and from our
standpoint, we can ultimately be the technical experts prosecuting patent
applications. Both of us feel we do that pretty darn well. But the best thing
we can do as patent counsel, and this is playing off some other comment that
the venture capital people made, is finding a way to have a better, more
informed strategic entrepreneur.
MR. LONGWELL: And there is the question: when are you legally ready,
and when are you strategically ready? A lot of inventors are legally ready
fairly quickly. They have enough knowledge of their invention. That’s
certainly my experience. You don’t need a lot of data. You don’t need a
prototype. It is pretty easy to describe a lot of business methods and software
communications inventions that I see.
So you can be legally ready to patent quite quickly. Because of that, there
is a rush to patent, and in most of the world, we are still faced with first-tofile, where the first invention to file is entitled to the patent,21 Within the
United States, which remains the last reasonable first-to-invent country,22 and
then you are strategically ready. Sometimes they file their own provisional,
or use other counsel before coming to us and looking for assistance.
Strategically, they weren’t ready, but their deadlines are coming up. It is
now the tenth month, and they have two more months to file a PCT, and they
literally have no money left. The PCT application, it is on the order of $6 to
$8,000, and they don’t have that money and want to come to the bank of Jim.
Do I help you? Well, why? I don’t know you from Adam. I can look at
your technology, and I can try and get excited, but I have to sell this to my
partners as well. I am not going to fund you until you find funding, and that’s
a tough, tough call. We are really not in the business of investing in our
clients. It is not good from an ethical standpoint I don’t think. We saw a lot
of that in the 1999-2000 range, and law firms have been burned by that. And
so it is a tough decision.
We have to be flexible and you have to come up with good payment plans
to allow our clients to avail themselves of the IP provision, but we also have
to be, sometimes, the gatekeeper and just say no.
MS. DOBREA: We don’t want to forget, there are other forms of IP,
right? To have an IP position, you have to have a trade secret, which may
equate to know-how. You have to have something that can be patented or
protected by its identification and goodwill, which would be trademark or
trade dress or something that can be protected by copyright. Unless your
21
22
Rose & Anderson, supra note 19.
Id.
261
business model is just to aggregate intellectual property rights so you can
enforce them against others when they stumble across your field, they are not
an end unto themselves.
While I believe that’s a well-understood notion by investors and
entrepreneurs who are great, wonderful people, who come up with these
wonderful ideas and push the envelope, they don’t necessarily appreciate
what a patent is and what it isn’t. Mostly we are going to talk about patents in
that context, and then – that it is not an end unto itself, and it doesn’t solve
our problems.
And how you go about trying to secure protection – it is a decision best
made after you have understood what that opportunity is. So going back to
the earlier discussions, starting with David Morgenthaler, there has to be a
business opportunity that makes sense. There has to be an innovation that
plugs into that opportunity, but there has to be an opportunity.
There has to be money. Someone has got to underwrite it. Maybe it is not
a lot, and you need to have all the resources in structure to carry forward,
whatever that may be in the industry. But the mere recognition that there is
an innovation doesn’t automatically necessitate that you go to the Patent
Office and file an application because, depending upon your business model,
maybe the ability to market a patent pending when you are showing it over in
Hong Kong is all you really need to keep your competitors far enough at bay
before you go into the marketplace. Since you have already a presence there
and recognition, it is going to carry itself and may be weak from a patent
perspective, too.
That doesn’t necessarily make money VCs excited because they think the
payoff at the end isn’t necessarily there, but that is a relevant strategic
thought process for some of the entrepreneurs who deal with it. Others have a
very complicated, and perhaps very robust position, from an IP standpoint,
and making a decision as to how to understand that, how to capture what they
have got and also sort through what their risks are in terms of stepping on
someone else’s toes can become a much more complicated and expensive
undertaking. It can only be done most effectively if they really understand
the opportunity, know the market they are going into, who is the competition,
and are they a little guy.
And there are a bunch of big guys out there who have a bunch of patents,
and that’s maybe death to the idea, but maybe that’s an entrepreneur’s way
in, in and of itself. You found a way to do something that the market hasn’t
figured out yet. You are not going to go nose to nose with Johnson &
Johnson, but you may have found something that tucks nicely into their
portfolio and it makes sense for your business to develop that to a certain
point and then transition it off to them.
When do you contact them? Do you try to get cross licensing? Do you try
to do a deal of strategic partnership? Those are the kinds of questions that
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come out of thinking in the first instance about what the opportunity is, what
space am I going into, how long is it going to take for me to get to market,
how much is it going to cost, and what are the risks if I fly blind and I have
no idea whose toes I am stepping on. How much money did I spend, and do I
stand to lose, if I have to stop in my tracks and pull my products out or try to
defend an infringement action and pay damages?
And that’s really all there is to it. Patent attorneys, again, we love that you
come early, you have an idea. You know, we do all the thinking upfront, get
your patent applications filed, and at least, when we are prosecuting your
case, the world is as controlled and encapsulated as it can be. But that whole
process in and of itself can cost so much money that it would be cost
prohibitive to a small entrepreneur who has got $200,000 in his or her pocket
to try to get out there and make something happen.
And so really, again, you know, the more we can help them sort through
those questions and maybe give part answers – understanding we won’t have
certainty on this. You can’t afford to have an opinion written on this, but we
can see what the environment is.
We can understand that there may be some patents that could potentially
block you; they could be invalid. The scope of the claims might not be as
broad as they appear to be. They might be held by big competitors in the
marketplace who can block you. But knowing that those rights out there exist
creates the opportunity to develop business solutions, business strategies.
So it doesn’t necessarily blow you out of the water. Again, flying blind
and not knowing what’s out there isn’t necessarily a terrible thing to do as
long as you figure out that you can afford to pull your product back.
Whatever you put into it, worst-case scenario, you get back a cease and desist
letter, or they file a lawsuit, you can just close up shop and move on and life
goes on. You are willing to take that measure of risk.
Once you get money people involved, they are going to dictate a little bit
as to how far they will go before those questions need answering.
MR. LONGWELL: I wonder, throwing the question back out to the
audience, particularly the VCs, is there a difference do you think? I think
there is, between due diligence in Canada and due diligence in the United
States when you are making an investment? The placements in Canada tend
to be significantly smaller.23
There is only so much in the VCs’ hands to pay for transactional costs to
make investments. They are going to try and shift the risk back to the people
seeking the money to prove the respect of their IP. Most of the arrangements
I see, due diligence is one of the areas, particularly in IP, that people talk
23
See generally Hilary Davidson, Goin Down the Road: Why are Canada’s best
Entrepreneurs Heading South? It’s more than the Money, PROFIT MAGAZINE, Oct. 1, 1999.
263
about, yet it is one of the first things that gets popped. And there is not a
significant amount of freedom to operate type of analysis. It is not done in
most places that I have worked in.
I don’t know if that’s the same for Diane or not.
MS. DOBREA: It varies, and it depends on the client. My university
clients who have a license for technology, frankly, they don’t care whether
we do any searching or not. We will tend to do searching so we can write an
application that best covers their invention and deals with the art that is out
there.
Clients, existing firms, the firms are entrepreneurial by spirit but not
entrepreneurial by some people’s definition, and they want to know because
they are planning to launch a product into the marketplace. They need to
understand what their risks are. Frankly, some of them, and I, from a
business standpoint, completely agree with the decision, will find a patent
that looks like it falls exactly within the scope of its claims. It looks like there
is a lot of good reason to think their patent would be invalid.
So you make a decision, take a risk, and there is a willfulness to it. So
they want to look, and they are going to make a real business decision. There
are also those who are not quite married to any particular concept. I am
thinking about smaller companies in the marketplace who have got cash flow
from existing products that have gotten things in their pipeline. They are
trying to decide whether to spend the next $50,000 on an FDA study on a lot
of gut response. What do you think? And it is not a competent opinion. You
can’t be definitive until I do the complete analysis.
So the question is: can I find anything that is right in the middle of the
road? And you make business decisions on where you are, and if it is not in
the middle of the road, sometimes we identify points of novelty in the heart
that people are inventing so we can focus and design around strategy if that is
needed. So it varies.
In some of the transactions that I have dealt with, you know, we have
done full-blown due diligence analysis and written full-blown opinions. But I
would say as a general rule, irrespective of how small an entity is or how
large and deep their pockets are, you just don’t do it on most properties
because it is, in and of itself, cost prohibitive no matter how wealthy the
company is.
Their portfolio is that much bigger, which means they are going to be
writing big checks for due diligence analysis. So at some point, it is just a gut
decision, and if they are well established in the market and they know the
marketplace well, what their own existing patent strategy is, and the
knowledge of the players is probably going to help them a lot versus an
entity that is going into a new area or a brand new startup that really is not
familiar with going into it at all.
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PROFESSOR KU: Since there are no other questions I wanted to ask one
in particular, and that is, you have already pointed out some differences
between U.S. and Canadian law and patents. Clearly, there are differences
between the U.S.-Canada and internationally.
Are there any reasons from a patent law, or other intellectual property
perspective, for an entrepreneur to consider forum shopping, for example,
choose a regime that might be more favorable, or are they pretty much going
to be stuck with, or governed by, the law and the nature of the jurisdiction in
which they do business?
MR. LONGWELL: Yeah, I will chime in because that’s something I do
almost all the time – is forum shop. The Canadian Patent Office is not a
major player in North America and, therefore, not in the world.24 Most of our
inventors look elsewhere to file their patent applications.
I worked for a company who filed their first application simultaneously in
the United States and Europe, but they don’t file in Canada until much later.
So forum shopping is exactly what they do. Now, I think it is a little different
in the United States because you have specific requirements to obtain a
foreign filing license, primarily on security reasons, before you can file in
another country.
We don’t have that defined in Canada at all. You can file anywhere that
you want.25 Last year at this conference we heard about forum shopping on
the litigation front and how prevalent that is and there are absolutely people
doing it with regularity. They are sued in one country or didn’t have a
problem with a particular market, but their IP position there is not great.
They are going to forum shop and possibly sue them in another jurisdiction
where they can either impeach that patent – that might be in the United States
and get the leg up on that litigation – or where they can use their own patents
to their advantage in that other market and bring it to courts there.
And I think that was really interesting, the statistics that Mike Elmer had
last year at this conference, and talking about forum shopping.
MS. DOBREA: The bottom line is, where you protect needs to be decided
based on where you see your product going into the marketplace, where there
is a market for it, so you are not going to protect everyone, and you are
hardwired. Again, once you filed an application somewhere, you do it with a
finite period of time, you have to make a decision as to whether or not you
are going to avail yourself of the right in any other jurisdiction under their
patent laws.
So forum shopping is certainly more relevant I think in the enforcement
context or in order to use some leverage in one market to derive a result in
24
Marcus Gallie, Canadian Patent Prosecution, http://www.ridoutmaybee.com/Pageasp?
PageID=122&ContentID=779 (last visited, Oct. 22, 2007).
25
See generally Rose & Anderson, supra note 19.
265
another. But in terms of taking advantage of the patent system, it all ends up
running together. Then, of course, you can get vastly different results in the
prosecution in different jurisdictions just based upon how the rules work.
We talked a little bit about what the government is doing to help, and I
will temper my comments about the U.S. Patent Office, but it is expensive.
MR. LONGWELL: Is there a stop on this recording?
MS. DOBREA: It is getting more expensive. I am not sure of the extent of
the audience’s familiarity with pending rule changes at the Patent Office that
have most U.S. Patent attorneys shaking in their shoes. We are stressed
because of the amount of time and effort that we will have to put in to carry
applications, think strategically about claims, and how many claims we have
searched and how much art we need to cite, especially in view of Federal
Circuit Court decisions about inequitable conduct and duties of disclosure.
We have a very challenging patent system already, and it looks like it can get
much more challenging and much more expensive, and that’s in sharp
contrast to Canada’s system.
MR. LONGWELL: Absolutely. We sort of have the kinder, gentler patent
system in a way. I don’t know if that reference is appropriate, but costs in
Canada tend to be lower historically at the filing stage and at subsequent
stages. We don’t have the rule requirements you have inherent in Canada –
good faith, and the obligation to disclose what you know that might
materially affect patentability to the Patent Office.26
We only have to tell what we know or are asked. That’s one big
difference, and it is a lot cheaper, obviously. We don’t have the rule changes.
We don’t have fees for the different numbers or types of claims that you may
have in a patent application. So it is a little easier. But the delays in our
Patent Office even exceed the time in the United States Patent Office.
When you are looking at a software invention that might not issue for five
plus years, or biotech, which can be six to seven plus years, this can dissuade
people from even patenting in Canada because technology turns over so
quickly. That’s another reason.
But recent rule changes in Canada tend to go a little bit the other way.
Proposed changes last January were arguing with the reduction and burden
on applicants, and they are eliminating fees, or proposing to do so, and to
make some difficult decisions. We presently have a reduced fee structure for
small enterprises.
We are trying to enhance those and encourage more filings. We heard,
earlier today, comments from Mr. Hisrich about the number of filings in the
United States, and there was only one instance where the U.S. was outpaced
by foreign filers. In Canada, it is, year in and year out, due to population, on
26
See generally Charles Lipsey, Canadian Court Decision Places Broad Class of Patents
in Jeopardy, MONDAQ, Aug. 17, 2007.
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a scale of anywhere from 7 to 1 to 9 or 10 to 1. This means that a good
portion of my business involves acting for foreign IP owners. But it also
means that our Canadians are not filing at anywhere near the same pace that
inventors are and entrepreneurs are in other jurisdictions. That’s a gap that
we have to close if we are going to remain competitive. We are going to have
to have to encourage the further development of our knowledge-based
economy.
MR. ABRAHAMS: This is a quick question for Diane: is it not possible
that the cost for patent filings in the United States has been pushed because
the USPTO has been privatized, and that’s how they get their revenue? It
seems like there is entrepreneurial cost recovery, and the government has
been that way for a while.
MS. DOBREA: Yes. I think there are other at least equally significant
factors, including the diversion of fees to other federal government activities,
which may be what underlies the Patent Office’s push to what will
significantly drive up costs for applicants.
MR. ABRAHAMS: Americans are considered privatized.
MS. DOBREA: I don’t really think that’s it. And I say it only in the nicest
of senses. I mean, it is already really expensive, and the fees that our clients
pay to file an application, to take modest extensions of time are pretty
significant already, and we cost a lot of money, too. So that adds to it.
We also have a very active Federal Circuit Court that looks at patent
questions and tends to confound what we thought were relatively clear rules,
necessitating us to do exactly the things the Patent Office doesn’t want,
which is to file more prior art references.
And I say prior art; I never admit anything is prior art. Let them say that,
but art references and the changes of the rules are going to necessitate that
we either limit our disclosure to prior art to 20 references or start describing
why we are not materially impacted by that art.
And that creates a mess when it gets to litigation down the road because
we have spun those references, and we have made representations, or we
have made admissions. Gosh knows what we have done.
MR. LONGWELL: Right. In Canada, for example, the activity in the
Patent Office, unless it is fraudulent, is not a consideration of litigation.27 So
you can almost effectively suck a blow at the same time. You can tell the
Patent Office one thing and get to court, and if what you said was not to your
advantage, you can tell the court.
MS. DOBREA: Yeah. Whereas filing wrapper estoppel in U.S. litigation
is a huge component.
27
See generally Damien McCotter, Using Electronic Records in Patent Proceedings,
MONDAQ, June 6, 2007.
267
MR. LONGWELL: It complicates the process in the United States
immensely where we don’t have that in Canada or other parts of the world. It
is a huge difference in cost. So cost per capita of obtaining IP in the United
States is high and getting higher, whereas in Canada, it is relatively high,
because we have a small population, but it is dirt cheap in China right now.
And you say, well, why would you file there? Well, China had no IP in
1980 and has an incredible amount of IP now.28 Is it getting better? Yes.
Where will they be in 20 years? Who knows, but it is likely only to get
significantly better. The pace of their programs is astounding.
We can’t get substantive rule changes through in Canada and are really
needful in terms of changing IP law. We have a sit-on-your-hands kind of
government approach to most of IP. Whereas in China, that’s different.
MR. ROBINSON: Moving on to another kind of IP, I confess my own
ignorance here, but I understood that Mexico has a trade secrets registration
protection statutory regime in force, and we don’t have that in Canada, and I
don’t think you have that in the U.S.
Has anybody had any interest in studying what the Mexicans have done?
Under NAFTA, we were all supposed to provide a high level of protection
for trade secrets, but it seems to me the only country that has done it is
Mexico.
MR. LONGWELL: Well, I don’t recall that the NAFTA treaty imperative
– making us having equivalent treaties. We only had to provide comparables,
and there was no obligation to add legislation. There were a lot of things
grandfathered along the way in the way we were treating each other.
And I don’t think I have heard of any study absent a registry for trade
secrets. It is hard enough to get the trademark registry working properly, and
that’s something that is out in the open. So I would be very surprised to see a
trade secret push.
PROFESSOR KU: In front.
MS. DOBREA: Douglas first and then –
DR. BARBER: I just want to ask a question about the defense of
intellectual property claims, and I suppose it is a question probably
principally about the trolls, and the trolls are probably not a big factor in
entrepreneurial activity because they go for big fish, not minnows.
Nevertheless, it ricochets into smaller companies, and I guess my question is:
it seems as though, at least when you get into the courts with these trolls,
which I have been involved in a number of times, that prior art doesn’t seem
to matter very much, and, in fact, they have settled out of court, recognizing
that you may have a very low probability of making a case on prior art. And
if you lose the case on prior art, your costs go way up because you can get
28
See generally Under the Dragon’s Breath, BUS. & FIN., Sept. 27, 2007.
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into penalties and all sorts of things. So, in fact, the trolls thrive on
settlements, out of court where actually the owners of the IP or the people
that are debating the IP believe that it has been a long time in practice, but
that the prior art is so well established that they can’t believe that this is even
on the docket.
MS. DOBREA: It is transaction costs. I mean, quite simply, if you really
feel you have a slam-dunk case, that you can blow their patent out and want
to at least make a run at trying to do that, then I imagine that would make
sense. But it is probably more likely that the troll just wants to exact a fee
that falls just shy of what it would take to litigate. “We want your litigation
cost less the dollar,” right? Assault their patent. But the analysis would be no
different than if you are, you know, up against a nose-to-nose competitor
who wants to blow you out of the marketplace. The analysis with respect to
enforceability or invalidity of that patent is going to be the same. And, yeah,
it is a little bit of a roll of the dice, just as much as an examination of a patent
can vary based on how familiar the patent examiner is with the rules of the
Patent Office and whether they really understand the technology, and that
depends.
Then you get into a court, and you are going to deal with the same
uncertainty. But the difference is that the party who is in the marketplace
with you, who wants to blow you out, is not just going to take a little fee,
whereas the patent troll, that’s what they do.
MR. LONGWELL: Eventually, they are going to march down to the other
fish. I don’t think you march to the fish.
MR. SHANKER: Everybody up until now has spoken about how good it
is to have entrepreneurs, which makes it good for our economy, et cetera.
Well, if a patent holder chooses not to be an entrepreneur or chooses not to
be a very aggressive entrepreneur, I have two questions. First, is there
anything in our patent law that permits other entrepreneurs to force this
person at least to license, to use that, and second, as a matter of policy,
should there be?
MS. DOBREA: Very good questions, but the answer to the first one is no.
I mean, the patent law doesn’t expect the patentee to be – it is not like real
property where you are making good use of the land and if you are not
someone who comes along and does make good use has the potential
opportunity to take over that land and have title to it.
It doesn’t work that way unless the technology was funded by the federal
government. Then through the Bayh-Dole Act and its implementing
regulations, there is some probability to yank that out of their hands.29 This is
29
See generally Sandy Kleffman, Debate Grows over Return from Stem Cell Program,
CONTRA COSTA TIMES, Nov. 1, 2005.
269
one reason why the clients that I counsel, who are university clients, in
licensing, have to make sure that, assuming we met all the other requirements
of the Bayh-Dole Act, that the licensees are not going to set the technology
on the shelf just to take it out of competition where there already exists an IP
position.
And that’s a difficult negotiation sometimes. But that’s just the way it has
got to be, and for their own best interest, they have to give some meaningful
thought to delivering on that promise because someone could potentially
invoke marketing rights and take the technology away from them if they
don’t try to commercialize it.
As far as whether, you know, there should be some change by Congress
to address this from a policy standpoint, I don’t know.
MR. LONGWELL: Canada does have a compulsory licensing provision.
So if you are not meeting demand, then there is a possibility.30 You can meet
all the criteria –
MR. SHANKER: Not meeting the demand of the marketplace?
MR. LONGWELL: Yes.
MS. DOBREA: So it is not just a matter of not actively commercializing
it, but there is no other market alternative.
MR. LONGWELL: Yeah. There are a number of factors that are in place,
that’s right, but you can under certain circumstances infringe in a sense and
pay a royalty.
MR. SHANKER: Of course, yes.
MR. LONGWELL: Yeah.
MS. DOBREA: No one mentioned this and we didn’t really talk about it,
but in the trade secret context – and it plays into what you just mentioned –
just from a policy standpoint, higher using rights – there is pending
legislation. Where the heck it will go, nobody knows, but there is pending
legislation to create a safe harbor for prior users who are using, practicing
secrets technology, whether it was a method or a composition embedded into
trade secret because right now there is no right if you have a product.
I had a client recently who had this issue. The product was in the
marketplace for over 30 years, and he maintained the formula as a trade
secret, and a couple years ago – and just came to the kind of attention, if you
don’t go into the market for them, that one of their biggest competitors got a
patent on that. And we analyzed it from a bunch of different fronts and
concluded that it is entirely likely that the competitor derived the invention
from our client, and the paper trail is that they submitted to the EPA this
same information that our client submitted 30 years ago in order to put their
product on this marketplace.
30
Michael I. Davis, Uniformity Flows from IP Treaties and EU Law, 19 NAT’L L.J. 37
(1997).
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That’s not proof, but we have some reason to believe if they ever try to
assert their patent against our client, that we could take them down on a
number of fronts. But there would be a big transaction associated with just
doing that, and the client was stunned. How could somebody stop us from
doing what we have been doing for 30 years, and the answer is there is no
clear answer. There is case law. There are a couple of lines of case law.
One case law says you will probably be okay because it is putting that
thing into the marketplace, and the possibility that it could have been reverse
engineered would constitute a disclosure versus the case. Well, if you have a
secret method in the current text agenda, we have got an executable code in
the software package that is not being sold. You are allowing access to the
sort of fine line, is there a disclosure.
Can anybody possibly reverse engineer, figure out what we are doing
there, and if the answer is no, then it has been effectively maintained as a
secret. Therefore, there was no prior art against that latecomer patentee, and
therefore, that latecomer patentee can stop you.
So while trade secret is a perfectly appropriate and viable IP to put in your
basket – an IP component to put in your basket of rights, there are some
risks, and if the law doesn’t change on that front, then there is risk it will
continue and is an indication to spend a lot of money on your lawyer some
day to try to sort that out.
MR. CHERNIAK: I don’t know if this is a fair question or not, but I find
a whole universe of patents – that patents are becoming much more abstract,
much more technically focused, much finer to distinguish from other prior art
or other innovations, particularly in the software world. Are you finding that
you are having to tell your clients, who are maybe software clients,
regardless of the strength of their patent, they will have to expect going
forward to run into other patents on technologies that will converge, even
stuff that is fairly distinct today, you may patent a chunk of a process, that
new technologies could end up in somebody else’s back seat. Are you having
to tell small entrepreneurial clients today to be prepared for that kind of thing
and to have the funds to defend that kind of thing? Again, I don’t know if
that’s a fair question.
MS. DOBREA: There are a lot of private art areas. And every once in a
while there is an innovation that comes along where you look at the patent
landscape, and unless there is something that hasn’t been published yet, there
is nothing there. Okay. That’s good. That’s really good from a freedom to
operate and from a patentability standpoint.
Now, maybe it is because there isn’t enough to waive the disclosure so
nobody is going to get a patent. But that’s really seldom the experience. In
Europe, we are, at least, taking disclosures that are in art areas where there is
again the university researcher side. There is a whole host of publications
271
that, at least, lead up to and are, you know, fodder for the patent examiner to
try to make out a case of obviousness.
But there are plenty of disclosures where either there are a lot of different
patents, lots of different ways to try to solve the problem that come off with
those few that our inventors come up with, and that’s where the cost really is
involved because you can’t tell them there is nothing there, and you can’t tell
them that what they have come up with isn’t the solution that is wanted in the
marketplace.
But we are going to have to find a way to deal with these patents that are
found, and it is simple enough to say the parties – maybe there is – maybe
there is one party that owns five patents all in that space, never resolved the
problem, but they may have a broad dominating set of claims that on its face
the patent is valid.
If that party is able to be acquired or is willing to license, there is a
business solution, so you can clear it up pretty quickly. If that’s a huge noseto-nose competitor in the marketplace, you know, they might not be so nice,
but maybe they want to find a solution.
So maybe they want to find your solution. So maybe that’s your exit
strategy, is to get it into their hands. We always tell – almost always – tell
inventors what they don’t like. That’s the reality. And the more they
strategize and think about what to do, the better chance they have got at
being successful.
Does that help?
DR. KING: Ray, one more question.
PROFESSOR KU: Okay.
MR. BROWN: I don’t know if you have heard of the patent auction that
has been proposed, but in Japan they are talking about a university-based
patent auction system.31 If you have heard of this, would this be a good thing
for entrepreneurs or a bad thing?
MR. LONGWELL: I am trying to think. Is it a good thing or bad thing? It
is not much different than homes that are real estate put up for auction. It is
there. It is availability. It is an asset that should be freely traded. I can’t really
comment if it is a good thing or not.
Apparently, there are bargains to be had, and some people have been
successful. If you read the promotions for these services, they have been
successful, but I have not had experience.
MS. DOBREA: The real estate analogy is a good one. I can imagine that
there are some points on which that analogy breaks down, but to the extent
you have got a piece of real estate, to think of it as a real hard thing, then,
31
See generally Rick Merritt, Bids Far, Few Between at First Patent Auction,
http://www.eetimes.com/showArticle.jhtml?articleID=185301101 (last visited, Oct. 22, 2007).
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however, you try to sell it, it is not going to change what you’ve actually got
and not going to change what someone else has got.
It may alter the dynamics in the marketplace. It may make it harder or
easier for someone else to be successful. It may overvalue or devalue
property. It could with any other kind of property. It is not going to alter
rights.
So is it good or bad? It is a shot at finding another way to meaningfully
get technology transferred into the marketplace, and presumably if the buyers
know what they are buying and have a plan to do something with it, then it is
probably a good thing.
MR. LONGWELL: Just one last comment: The patent system is sort of
like a bargain with the state. The idea is you disclose to the state which will
present it and publish it as an application or as a patent, and we will teach the
world how to use – to make and use – your invention with the idea that we
are going to actually foster more knowledge; that we are going to create, put
into some other entrepreneur’s head a way to design around that patent right
so that we are all smarter, so that we don’t end up copying.
People say it is horrible. If there were software patents we would have no
more innovation. Well, not actually, you would probably just have more
copying because there wouldn’t be any need to get around the patent.
So anything that brings forward the idea that there is more value to having
a patent and, of course, being a patent practitioner, I think that is probably a
good thing that people recognize what they are good for and how they can be
used. So I don’t really have a problem with auction.
PROFESSOR KU: All right. On that, I would like to thank Jim and Diane
and also comment that, one, patents can be very valuable and serve these
purposes, but then, Diane, your troubling comment that you often feel like
you are telling inventors, no, they can’t do these things or raising these
problems.
MS. DOBREA: And, you know, because I try to deal with the inventors
in a very business-like fashion, I try not to be the lawyer that says you can or
can’t do these things. The better they understand the landscape, the better
they can make decisions. They are real.
Somebody has a patent that is in their space, it is real. Now, maybe you
look at it and know who they are. You know you are not really directly in
their competitive market space, and they will never come and do anything to
you, but if you don’t know they are there and they send you a cease and
desist letter and you just spent millions of dollars on packaging and
marketing and distribution just to pull that out and never be able to sell one
product, that would be a pretty rude awakening.
So I don’t tell them what they can or can’t do. I tell them what the
landscape is and help them to make strategic decisions.
PROFESSOR KU: Thank you both very much.
CAPITALIZING ON THE SUCCESS OF ENTREPRENEURSHIP:
IPOS, PRIVATE SALES, TAX ASPECTS, RESIDUAL INTEREST
OF ENTREPRENEURS AFTER SALES OF IPOS
Session Chair – Richard Gordon
Canadian Speaker – Anthony Penhale
United States Speaker – Elizabeth Dellinger
INTRODUCTION
Richard Gordon
PROFESSOR GORDON: Henry isn’t here, and I may be the person who
will start things off. I am Professor Richard Gordon. Those of you out there
who are – and I guess down here as well – who are lawyers and not
yourselves entrepreneurs, I don’t know if you have had the same sort of
reaction that I’ve had the past couple of days, hearing so many successful
entrepreneurs speaking. I haven’t even thought of myself as a lawyer, but as
one of those other “L” words – “loser,” because I haven’t made a gazillion
dollars and lost it and made it. And I am hearing constantly the descriptions
about how special entrepreneurs are, and I have been feeling increasingly,
well, diminished, I guess would be the best way to put it.
I was a tax lawyer when I was in practice, and I am very pleased – I was
actually pleased to hear the previous panel as well because there are - we are
hearing about the value added lawyers can bring to the process, specifics, and
that made me feel a little bit better as a lawyer, talking about some tax issues,
and that made me feel even better as we turn to what lawyers really do.
We are also getting to the fun part, which is capitalizing on success.
That’s always a good thing. So I am not going to actually make the
introductions because I don’t know either one of our distinguished panelists,
although I know they are distinguished.
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Elizabeth Dellinger∗
&
CANADIAN SPEAKER
Anthony Penhale∗
MS. DELLINGER: Great. Well, my name is Betsy Dellinger. I am a
partner at a law firm here in Cleveland by the name of Baker Hostetler. I
chair our private capital practice. What that really means is my practice
involves representing venture funds, representing startup businesses,
representing what I often call emerging growth companies, privately held
companies and basically working all sorts of capital formation. You look at
a business, look at their capital needs, match up the two, do the legal work,
do a lot of strategic counseling and let the companies grow but stay out of
∗
Elizabeth Dellinger focuses on transactional, capital formation, corporate and contract
work for privately held companies, capital restructuring, executive contract and strategic
business counseling. Her clients include investment fund portfolio companies, manufacturing,
healthcare, aerospace, insurance, bank and non-bank providers of senior capital and
institutional and individual providers of mezzanine and equity capital. Ms. Dellinger
represents clients in capital restructuring and workout transactions, as well as counsel to
secured lenders, equity stakeholders and corporate constituents. She is also active in the
Negotiated Acquisitions Committee of the American Bar Association’s Business Law Section.
∗
Anthony Penhale is a partner and a member of the Business Development Committee in
the Montreal office of Stikeman Elliott and a member of the Corporate/Commercial Group.
His practice is focused primarily in the areas of securities transactions, corporate finance,
mergers and acquisitions, privatizations and divestitures. Assignments have included advising
a broad range of issuers and underwriters in the context of public offerings and private
placements, counseling issuers in connection with securities matters, and advising entities in
connection with public market or private acquisitions or divestitures. In addition to Canada,
his work experience includes transactions in the United States, the United Kingdom and
Eastern and Central Europe, particularly Hungary where he was seconded for a period of six
months. Mr. Penhale is featured in the publication The Best Lawyers in Canada, 2008 edition
in Corporate Law and Securities Law. Mr. Penhale is a member of the Quebec Bar, of the
Canadian Bar Association and of the American Bar Association. In addition, he is a member
of the Association for Corporate Growth.
Penhale & Dellinger—Capitalizing on the Success of Entrepreneurship
275
their way and then helping them exit and realize on to other potential
businesses.
Anthony will introduce himself, and then we will give a presentation
where we sort of lead off, go back and forth between us and feel free to jump
in with questions as we go.
MR. PENHALE: My name is Anthony Penhale and I am a partner in the
Montreal office of Stikeman and Elliott. I principally deal ultimately with
the tail end process of what we are talking about, once the company has been
taken public or bought or sold, typically bought by somebody bigger or
private equity in this context.
Our offices are throughout Canada, mainly in Toronto, Montreal,
Vancouver, Ottawa, Calgary; we deal with a number of different capital
raising functions and obviously a lot of tax planning for which I must put a
disclaimer right away – I am not capable of explaining anything correctly
when it comes to taxes.
MS. DELLINGER: We have a number of slides here, and I will loosely
follow them. I will start with this one, “Capitalizing on Successful
Entrepreneurship: When and How.” On the “when,” there are two times
when you, as an entrepreneur, will not capitalize on your success. The first is
when VC (venture capitalist) money comes in to fund the growth of the
company.
Venture capitalists put a lot of money into the company, but they don’t
want to see it spent on the management. They want management and the
founders of the company to be tied in closely with them as co-investors in the
growth of the business.1
The second instance in which you will not be able to capitalize on the
success of your entrepreneurship is when some form of cash compensation is
being drawn from the company during the growth stages of the business. I
think entrepreneurs are uniquely the hardest working people out there for the
lowest relative compensation, because their opportunities to realize success
come closer to the back end of their activities than at the front end during the
course of the entrepreneurship.
That said, in this presentation we really want to address when an
entrepreneur will experience success and how best to achieve it. There are
three basic categories of exits from a company. A liquidity event is really the
definition of how the entrepreneur realizes the success of the business. As I
say this, bear in mind that there could be two types of entrepreneurs growing
the business coming in to a liquidity event. One is the person who started the
company, a family-owned business that is now looking for an exit. The other
1
See generally DAVID GLADSTONE & LAURA GLADSTONE, VENTURE CAPITAL HANDBOOK:
AN ENTREPRENEUR’S GUIDE TO RAISING VENTURE CAPITAL 103 (FT Press, rev. ed., 2001)
(discussing how a venture capitalist evaluates management).
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is a venture capital funded business. When venture money comes in, the
control shifts in a variety of ways and timelines are sometimes more
predetermined by the fund’s particular commitments to its investors and
when the fund plans to withdraw from its investment.2 So these factors can
have a bearing on what the exits are and how they happen.
Liquidity events can occur first in the form of a private sale. Such a sale
could be to a strategic buyer, to someone else in the industry, or to a more
mature equity fund or second state venture fund. Second, they can occur in
the form of public sales, typically called “initial public offerings,” or IPOs. A
third type of liquidity event is a recapitalization event. We will drill down on
each of these a bit, but recapitalizations are basically a way of selling part of
the business and holding on to another part as the business continues to grow.
MR. PENHALE: All right. Just before you move on, there is perhaps a
distinction we can make between what I think is a reality in the Canadian
market in contrast to the U.S. market. In the Canadian market, at least in
Quebec, if you look at the 50 largest companies, you would not be surprised
to find that two thirds of them are either controlled by a group of
shareholders – public and private – or controlled by the family that actually
founded them.3
I remember a number of years ago we were involved in a cross-border
IPO-related transaction. Our firm had been retained by counsel for the
underwriters, and we had the U.S. counterpart. We were looking at a
structure involving dual classes of shares, and you had half of the table
literally scratching their heads trying to figure out why there would be one
class of shares with more votes than the other class. How could you possibly
take this to market and what had you been smoking to think that you could?
And that’s a reality. Increasing the market of people investing results in
investors’ recognition of all sorts of governance issues to do with a class.
Still, even in an established public company in Canada, it would not be rare
to find that there is a controlling shareholder, group of shareholders or
family, who play a key role in decisions pertaining to liquidity.4
MS. DELLINGER: I will also add, and this ties into what Anthony said,
that it seems to me after having practiced law for 20 years, that over that
period of time, the exits for privately held companies, whether by private
2
See generally PAUL GOMPERS & JOSH LERNER, THE VENTURE CAPITAL CYCLE 346-347
(MIT Press, 3d ed. 2006) (1999) (discussing the exiting of venture capital investments).
3
See generally Andrea Jezovit, Marlene Rego, Zena Olijnik, Andy Holloway & Tom
Watson, The Big 50, CAN. BUS., May 21, 2007, at 28 (describing the top fifty Canadian
businesses).
4
See generally John C. Coffee, Jr., The Future as History: The Prospects for Global
Convergence in Corporate Governance and Its Implications, 93 NW. U. L. REV. 641, 688
(1999) (discussing the potential for controlling shareholder threats of lost liquidity to public
shareholders).
277
sale, public sale or otherwise, have almost become commoditized somewhat.5
Nowadays, someone declares, “Well, I am thinking about selling my
business,” and all of a sudden someone else jumps out in front of them and
says, “Here are the three ways you can do it. Here are the valuation models
and the agreements you are going to need, and this is how you are going to
sell your company, and we also have a list of the 50 best candidates to sell
your company to, and we are going to narrow that list at auction.”
There are virtues to that because, in some respects, that makes the market
more efficient and some of the auction processes that have been created by
investment banks, large or small, tend to increase valuation. On the other
hand, when something is commoditized, there may be something lost in that
process, too.
There is one thing that I always encourage an entrepreneur to do: look at
the whole package of options, listen to what the professionals have to say,
and pay close attention for the option that sounds prepackaged. They might
be selling to the company you can compete with versus what is really, really
important to your business that may look for the particular value proposition
your business offers and really help promote that piece of it and actually got
lost in the process.
The first method of exit that we will focus on is the private sale. There are
two types of potential buyers out there when dealing in private sales. First,
there are “strategic” buyers, who are people in the industry or companies
looking to buy companies and equity funds.6 Second, there are equity-fund
buyers.7
It used to be that you had venture capital, and then you had traditional
equity funds and it was somewhat uncommon to have an equity fund sell to
an equity fund. The opposite is true today. Now this is one of the most
common types of transactions being made.8
The other word you see flying around in the media is “hedge funds,” but
from the entrepreneurial company standpoint, an equity fund and a hedge
fund are really the same thing. An equity fund is a pile of money that is
5
See A business broker directory: Connecting business buyers and sellers,
http://www.businessbroker.net/ (last visited September 27, 2007).
6
See Michael L. Sklar, A Full-Court Press to Sell a Business, MERGERS & ACQUISITIONS
J., (2004); see also, ANDREW DOLBECK, COMPETITION FOR DEALS: THE RETURN OF THE
STRATEGIC BUYER, WKLY. CORP. GROWTH REP., (2006).
7
See generally Martin Sikora & Joan Harrison, Gusher on the Sell Side: Massive liquidity
is fueling selling ardor and high prices, MERGERS & ACQUISITIONS J., (2005) (discussing
business purchases by equity funds and others).
8
See generally Press Release, PR Newswire, Private Equity Boom Over: Firms to Look
to Smaller Deals, Distressed Opportunities, Say Keynotes of Today’s Dow Jones Private
Equity Analyst Conference (Sep. 19, 2007), available at http://www.prnewswire.com/cgibin/stories.pl?ACCT=109&STORY=/www/story/09-19-2007/0004666114&EDATE= (noting
a company’s return to all-equity deals).
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funded, either by individuals or institutions or pension funds, that is looking
for a place to make money outside of the traditional public market series of
private investments.9 They are looking for businesses that can run themselves
and make money on their money, versus the strategic buyer who is really
looking to have innovative business with its current operations.10
MR. PENHALE: There can also be some confusion between strategic and
financial buyers because they can strap onto one of their foreign acquisitions,
causing a party that is seemingly a financial buyer to behave like a strategic
buyer.
MS. DELLINGER: Certainly, and I have another slide that will address
that very issue. At this point, I would like to discuss the valuation of a
business. It used to that a strategic buyer would almost invariably pay more
than an equity fund in a private sale because there were synergies of the
strategic buyer coming into the transaction.
They had more ways to reduce the costs of the business so they would be
able to pay more upfront because of these cost savings. By contrast, what you
find now is that there is so much money in these equity funds that they are
forced to put out that money. If they don’t, then they have commitments from
investors that they are not rolling into investments. Those investments then
aren’t getting a return on capital, and so that impacts the total rate of return
that the equity fund is producing.
So the equity funds are really motivated to put money out there, and they
are paying multiples for businesses that would have been unheard of a
decade ago. Was that your experience?
MR. PENHALE: It was. We had a phenomenon that sort of mimicked
that in Canada, and you may have heard of it. It was called “income trust” or
“income fund.”11 This was an absolutely efficient flow-through mechanism
that a company would buy based on a multiple of the cash flows, thereafter
distributing all of its available cash from operations.12 In return, it would get,
instead of the traditional, let’s say, seven times or six and-a-half times, that
might be rigid and might turn on a sale, they would get closer to seven, nine,
and sometimes 12 times, depending on the business that they were in.
9
See generally CLIFFORD E. KIRSCH, FINANCIAL PRODUCT FUNDAMENTALS §15:2.1
(Practicing Law Institute 2004) (defining equity funds).
10
See generally JOHN LELSLIE LIVINGSTONE & THEODORE GROSSMAN, THE PORTABLE
MBA IN FINANCE AND ACCOUNTING 595 (John Wiley and Sons 3d ed. 2001) (1992)
(discussing how a strategic buyer seeks to integrate its operations with the purchased
business); see also DUNCAN HUGHES, ASSET MANAGEMENT IN THEORY AND PRACTICE 70
(Lessons Professional Publishing 2002) (stating that an equity fund manager seeks to provide
an element of income for investors).
11
See JILL BOOKER, WEALTH MANAGEMENT AND ESTATE PLANNING 16-77 (CCH Canadian
Limited 2d ed. 2006).
12
Id.
279
But if you take seven and nine on a $10 million business, there is an
automatic pickup of $20 million in value. So this was very, very lucrative. It
disappeared, or at least it is going to be disappearing because the
Government changed the tax scheme with regard to these entities last fall by
announcing that they will essentially tax them as corporations, much as they
started to do with partnerships a number of years ago.13
This was such an efficient vehicle to buy and raise money and it also
offered the ability, which was uncommon in Canada until then, to basically
sell 100 percent of the business to the public. Normally, you would have a
retained interest or concern of flash-in-the-pan and dealers telling you, “Oh,
you got to have some skin in the game, or we won’t buy.”
With the income trust, you could buy 100 percent of the business and
ultimately have no retained interest. At least with the equity buyers that we
were seeing in Canada, you also had to up their valuation because, to be
effective and competitive, they would offer more than the seven times, closer
to the nine, which upped some of the funds.
MS. DELLINGER: Before we spend another minute talking about
valuation, it is important to remember that you are getting this from two
lawyers, not investment bankers. The valuations in private sales hinge on two
timely factors that influence what I see.
One is the nature of the business, the industry, and the uniqueness and
value of its technology. The second is the size of the business. In a smaller
company that makes sort of commodity widgets, if they are going to sell the
business, they may be talking about a multiple of four or four and-a-half
times EBITDA, which is earnings adding back in tax and depreciation
amortization, so sort of real net earnings of the company.14 With a really tiny
company, you start talking about a one-time revenue, but that pertains to
companies that are coming in at $100,000 or $200,000, and EBITDA. This
isn’t a relevant number for that, but for a company that has an operative
history, EBITDA is sort of the commodity measure of valuation with a
multiple attached to that.
In a company that employs a little bit more groundbreaking technology,
that is in a little bit of a sexier industry, and that is a little larger, you are
going to find multiples going up six, seven, eight, nine times. With a
company that happens to be the jewel of the marketplace, like an aerospace
company, an industry that is hot right now, you will see larger aerospace
13
See Press Release, Canadian Department of Finance, Canada’s New Government
Announces Tax Fairness Plan (Oct. 31, 2006), available at http://www.fin.gc.ca/news06/06061e.html .
14
GUY LYNN, A DICTIONARY OF ACCOUNTING AND AUDITING 342 (Xlibris Corporation
2005); see also Ben McClure, A Clear Look at EBITDA, INVESTOPEDIA, A FORBES COMPANY,
April 24, 2006, http://www.investopedia.com/articles/06/ebitda.asp.
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deals being priced at nine and-a-half, ten, 11 and 11 and-a-half times
EBITDA.
Two years from now aerospace won’t be in the limelight. It will be
something else, but that’s what we are talking about in terms of valuation.
You want to talk about big companies versus little companies. If a company
has $100 million in revenue, for the purposes of this presentation, that is
what I consider a bigger company. With something smaller than that, you
don’t usually get even a little ding on the valuation in my experience.
MR. PENHALE: Except we have a lot of media stock right now.
MS. DELLINGER: The agency I am working with has an aerospace
company, and that is why they are so popular. I would like to toss this out. In
a private sale to a strategic buyer that is in the industry and will fold the
business into the company, oftentimes there is just no room for the seller’s
management. This is when you are talking about entrepreneurial companies,
usually the founders of the business going into the new company. Or, it may
be that the target company’s management is so much better than the
management of the existing company that they will displace them. But there
is certainly no assurance that the founders, the founders’ family members, or
the founders’ management will find a home, necessarily, going forward in
the long-term with the strategic buyer. With the equity fund, the equity fund
is a bunch of people who went to Wharton and Stanford Business School,
Harvard Business School and are good at crunching numbers and investing
money. They are not operating people, so they are going to need the
management and the founders, if that’s the case, to have the company run. At
times, we find that they have high growth plans for the company that they
simply can’t achieve. The entrepreneurs have taken the company as far as
they can, so they may bring in, and this would usually be negotiated, a new
CEO or some other skilled management to help the company hit the next
level.
Lastly, if it is done right and done well, it will benefit everybody.
MR. PENHALE: One of the issues you often hear about in public and
private companies is that, under Canadian law, if your venture fund investors
or fund investors have, in fact, negotiated that condition at the board level in
any context, private sales will occur, and your board will be asked to look at
things and try to disassociate themselves from those who put them on the
board to do what is best for the corporation or the entity. 15
And when dealing with management and management’s role, let’s say in
the sales end, you are selling to strategic, and in fact, your best negotiator is a
15
See MEL GILL, GOVERNING FOR RESULTS: A DIRECTOR’S GUIDE TO GOOD GOVERNANCE
103 (Trafford Publishing 2005)
281
member of management, you are going to have a possible conflict with their
own interest.
Whether they have a deal or not, they can get a deal or look at the world
and think, “You know what, some equity is not a big deal. I will get paid
now, some of the business now, get a three to seven percent stake and make
money as a salary, and make money down the road if they stay as well,” and
that’s their decision process and how they view a transaction.
In conflicts of board members, at least under Canadian law, you must do
everything that you can to act in the best interests of the corporation.16 That’s
a big generalization, but it assumes that the interest of the corporation does
not necessarily at all times equate to the interests of the shareholders or the
majority shareholders.
MR. GROETZINGER: I wonder if you could comment on the appropriate
time or an ideal time to be thinking about sales as opposed to looking for
more money to grow the business, and let me give you variables.
One is a group of entrepreneurs who come up and finally arrive at a
valuable patent issue but don’t have the money to move it forward any more
versus a company that is up and running and has a positive cash flow for the
last three or four years. What is your counsel on what is a good time to sell
out?
MR. PENHALE: I am glad I am just a lawyer. That’s what the bankers
do. You pay them the fees to make those calls. And you’ll notice that the
bankers have to do ten deals just to get paid on one of them. So they are
probably wrong more than half of the time. I don’t think you can say that
there is an objective “best time to sell.”
I think if you were to come into my office and ask me what I ought to do
in those two scenarios, we would look realistically at what your needs are,
what the cost to get to that capital is, and how realistic it is for you to get that
capital at a cost that makes sense for your business.
It is surely the reason for equity in the public market versus no guarantee
that you are going to get the valuation you want or that you are actually
going to get a deal. I know that way too many companies file a prospectus,
and somewhere through the process they allege that this is not going to
happen. And maybe you have an aggregate, a big banner for sale in your
company, and you are not in the driver’s seat any more. So you don’t have
guarantees.
You don’t have chances for success. You can’t equate automatically the
perceived cheaper cost of capital or cheaper cost to get the capital at a public
offering versus, let’s say, another round of financing, or an alternative round
of financing. And maybe, if you are looking to get VC financing, your
16
See id. at 39.
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advisor probably ought to tell you that you may not be in the market or look
at aims and alternatives but not as one of the conditions to it.
I am sorry if my answer is sort of “everything under the sun,” but I think
it is the best answer that I can provide under the fact patterns that you have
suggested.
MS. DELLINGER: I would say that it is not uncommon for me to have
someone in my office ask me, “Should I sell my company, and what’s it
worth?” – the two weightiest questions in any business. The entrepreneur
knows more about what their company is worth than really anybody else out
there. You need to help me as a counselor to put some structure around that,
to help determine that answer. The way I usually answer that question is,
“Let’s talk about what your company is worth.” Then we would talk a little
bit about common methods of valuation, a multiple, and what multiples
might be out there for their industry.
What do you think it is worth? If the multiple of EBITDA comes out and
the company is worth $10 million and you say to me, “I thought it was worth
at least $25 million,” we know the answer. You think it is a $25 million
company. You simply haven’t gotten the operations up to support that
number yet.
Hold on to it. Keep running it, and find some additional investment
capital. If you say “You know what, I am 63 years old, I have two good years
left, I have a house in Florida that is screaming my name, and I think the
company is probably worth $25 to $30 million; traditional analyses can
support $18 to $20 million.” Maybe, with some good massaging and a decent
investment banker in there to help fair market it, you can get there.
But you don’t want to say I need to sell it in the next day. You want to
give yourself a meaningful period of time for whatever weaknesses there are
in the business, and then you can key it up for a possible sale. The other thing
you can say is that “I think it is worth $25 million; let’s go test the market
and see what I can sell the thing for, but if I don’t get the money, I don’t
want to sell it.”
That’s a very dangerous proposition because once your company is on the
market, all sorts of things happen that are completely outside of your control.
Your customers may say “I was happy dealing with John Smith, but I will
not necessarily be so happy dealing with someone else.” Your employees
may get nervous, and competitors may see it as a sign of weakness. Your
competitors may come in and say, “I want to buy it,” and walk away with
information on the company, notwithstanding disclosure agreements that
they won’t do it.
So once a company is for sale, I think, the commitment to sell it really has
to be there. So that is sort of how I look at entrepreneurial companies.
Are there any other questions at this point before we continue on? What’s
next?
283
Public sales and IPOs. These are sales on to the public market. In my
experience, and Anthony’s up in Canada, setting aside 1998 to about the first
half of 2000 during the internet boom when reality was set aside for a period
of time, my experience is that entrepreneurial companies much, much, more
often through a series of new investments, partial sales and ultimately private
sales, didn’t ever really go to do public offerings.17
The number of registration rights agreements probably number in the
hundreds. The number I have ever seen exercised is zero. So this is an exit
that you’ve got to plan for, and as you are negotiating a sale exit from your
business, you are always negotiating against the alternative. This is one of
those alternatives that you are considering pursuing or negotiating against so
it is always out there. But they are talked about much more than they are
used in my experience.
MR. PENHALE: That would be true in Canada as well and as I
mentioned the income trust earlier on, but as a fallout of the burst of that tech
bubble in early 2000, investors were shell-shocked, and they were not
looking for growth any more on the price of the stock but for a monthly
return in cold cash every month.18
The tax lawyers and bankers came up with a structure, which was really
efficient for taxes, and that’s the only time we ever saw people really looking
at it as a viable alternative to build a public market as a new liquidity event.
MS. DELLINGER: I will add a couple other tidbits. In the United States,
I mentioned before how much money is sort of sitting in equity funds looking
for a home and for private sales and businesses. There used to be a gap, and
maybe you could sell your company in an eight times or six times multiple in
private sale and 20 times sale on public markets. You had to really look at
that meaningfully, but as multiples for private sales have gone up and as
public markets have come down a little bit, that gap really isn’t there
anymore to the same extent that it was. So you have the private money out
there really looking for good deals, on the one hand.
Secondly, in the United States, you have Sarbanes-Oxley, and depending
who you talk to, I believe the New York Times has a negative story and The
Plain Dealer has it as a positive story, but that Sarbanes-Oxley has done a
great job of giving investors confidence.19 And companies are thrilled about
it versus it being an extremely burdensome level of responsibility to comply
17
See generally JILL ANDRESKY FRASER, THE BUSINESS OWNER’S GUIDE TO PERSONAL
FINANCE: WHEN YOUR BUSINESS IS YOUR PAYCHECK 286 (Bloomberg Press 2002) (noting that
public offerings are an option for only a select group of entrepreneurial companies).
18
See generally Raymond Fazzi, Investors Get Down To Earth, FIN. ADVISOR MAG., June
2002, (discussing investor interests after the technology boom).
19
Jonathan D. Glater, Here It Comes: The Sarbanes-Oxley Backlash, N.Y. TIMES, Apr.
17, 2005, at 5; Alison Grant & Mary Vanac, The Hefty Costs of Compliance; Small, Midsize
Public Companies Hit Hardest by Sarbanes-Oxley, PLAIN DEALER, Mar. 15, 2005, at C1.
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with the greater corporate governance and the corporate oversight rules that
have come around in the United States since Enron.20 So that’s an impact.
MR. PENHALE: I was just going to say we are lucky in Canada; we have
the benefit of having you as a neighbor, you being the U.S. capital markets.
So we can take a look at legislation like Sarbanes-Oxley and see how things
go and how people react and tailor it in our own environment, which is
predominantly control companies smaller market cap.
So Sarbanes-Oxley, or the equivalent in Canada, surely is a pain but
probably is a good thing in terms of disclosure and enhancement of corporate
governance without the cost of annual million-dollar fees to do it. But it is
nonetheless an issue, and you have got to really keep in mind, even absent
Sarbanes-Oxley, that it is a million-dollar extra cost per year just to be
public.21
So when you are talking valuations, if you factor in the cost of
compliance and the cost of reporting transference requirements, suddenly it
may not be worth it to do it, and the private bar may have a strong incentive
to convince you to settle in.
MS. DELLINGER: One other thing I wanted to talk about is that there are
opportunities out there presented to privately held companies, and usually
technology based companies, faster growth companies that are looking for,
particularly, extra capital, and that is to merge the company into a shell
public company.
If someone calls our firm and says, “We have a company doing a merger,
we are going to become public, we are going to represent the public
companies and would love Baker and Hostetler to work with us,” those
transactions are just fraught with issues. They are usually some type of sham
because if you don’t have a company that could really get an underwriter to
support and do a traditional public offering, it is never going to have the
benefits of being public on the public market. There is not going to be a
market maker. There is not going to be anybody who really wants that stock.
The investors are not going to find liquidity. Usually on the public markets, if
there is not a buyer, you can’t be a seller. So, I’m sure there are one or two
out there that have been great successes, but there is usually something in
there that we run away from screaming.
Do you have something to add to that?
20
See generally Alwyn Scott, Board Members Debate Whether Reforms Have Cleaned Up
or Glossed Over Problems, KNIGHT RIDDER TRIB. BUS. NEWS, Oct. 3, 2004, at 1 (noting that
executives were glad to have everything out in the open).
21
See generally Mary Crane, Are You Ready To Go Public?, FORBES.COM, Nov. 16, 2006
http://www.forbes.com/entrepreneurs/2006/11/13/goldman-sachs-morgan-stanley-ipo-ent-fincx_mc_1113goingpublic.html (noting the costs of going public)
285
MR. PENHALE: We do. Some are good; some are bad. We have the TSX
Stock Exchange, and if you compare it to your large American counterparts,
TSX venture is really a junior exchange, but you have a lot of shell
companies in there.22
And it is really amazing, sometimes, when you are doing due diligence
for a tech company to try and raise capital, and you find out they have all
sorts of environmental issues because at one point in their life, they were
digging for oil. They really don’t know what they did for the last ten years
because they did nothing because it had a liability, potentially. If there is a
nice way of making a dollar quickly with little risk, they will probably find it.
These deals are more often than not too capital and too costly to market.
They are there. Still, sometimes this is quite a legitimate way to become a
public company.
You may have a private company that is the object. We call that a
“reverse takeover,” or “reverse merger,” and there is a real operating entity in
both companies.23 It is not just a shell.
MS. DELLINGER: Right.
MR. PENHALE: And you are buying an asset and paying with your
securities, and control changes as a result of that transaction. That’s one
thing. If there is just a shell to use the listing, you probably have more than
half a chance that it is not workable.
MS. DELLINGER: I wanted to –
MR. PENHALE: Do you want to talk about auctions before you
continue?
MS. DELLINGER: Yes, let’s do that. We sort of talked about valuation,
and I am going to hit on a couple of things. Valuations in public markets
have traditionally been much higher than in private markets, but that’s really
worn away in the last couple of years.
Management’s role, if you do a public company, you have your value –
you are selling your shares. You are not selling to another company that has
management keyed up. So to the extent you have a management team, the
entrepreneur who still likes to work and wants to work just keeps you in that
position with more liquidity and then lock it.
In an underwritten public offering, what you find is that the underwriter
will say, “Great, you want to take the company public, and in the long run
22
See Angel Capital Education: Toronto Stock Exchange Group Offers Options for
Growth, http://www.angelcapitaleducation.org/dir_resources/news_detail.aspx?id=136 (last
visited September 27, 2007).
23
DAVID N. FELDMAN, REVERSE MERGERS: TAKING A COMPANY PUBLIC WITHOUT AN IPO
20, 252 (Bloomberg Press 2006); see also GUY LYNN, A DICTIONARY OF ACCOUNTING AND
AUDITING 342 (Xlibris Corporation 2005).
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not only do you have better capital for the company, but you also will be able
to sell shares in the public market. But don’t do it on our watch.”
So you see these companies that go out, and the IPO says that its stock is
worth $50 a share and the stock jumps to $75 a share on the first day and
stays up there for a little while. Then it hunkers down, and six months later
the stock may be at $49 a share and seems to be pretty stabilized.
Well, 180 days is sort of the standard management lockup so management
didn’t experience any of that initial hype. And when I say management, I
really mean the entrepreneur in the business. Instead, once the company has
come out, they will have an opportunity to sell their shares, and I won’t bore
you with the methods into the public markets to get personal liquidity that
way. But the underwriters will look so that often investors are coming in,
knowing that the people who founded the business, who are running the
business are tied up and committed to the business for that initial period of
time.
MR. PENHALE: Right. And to that very same comment, this is very rare,
at least from what I have seen. As I said before, they sell a 100 percent stake.
You do a public transaction unless it was a buy, but if you are going to stock
exchange markets or listing, you can pop at 45 or 60 percent depending what
the underwriters told you the market could bear.
While there is some liquidity of selling, in fact, originally by your stake,
the company raised the capital that you didn’t really get as the entrepreneur.
You have a new currency that you show your banker that you can value
daily, but you don’t have a dollar more in your bank yet.
And as Betsy was saying, you have 180 days before you actually get a
dollar more, and then there are a bunch of rules that preclude you from
getting that dollar when you want it. One of the things that I find
entrepreneur managers don’t do when they think they are taking their
company public, is put themselves in the shoes of someone who invented
something, actually went through the VC analyst, still has a stake in it, is still
happy about the business, has done relatively well, and has got all the
financial metrics aligned so that you can come and get your brokers to call
you to invest in it.
And then you have a bunch of bankers and lawyers and people doing due
diligence of everything under the sun again and again and again. We describe
these individuals as crazies and, while creative, they are not patient, I can tell
you that.
More importantly, don’t underestimate their ability to manage the
business. The toughest part I think for members of the management team,
senior officers in the context of an IPO, is how unlikely it is that they are
going to be able to manage the business as they systematically underestimate
needs, wants, the timing issues and the requests that people will make.
287
We talked earlier about how extensive due diligence on the intellectual
property might have been throughout the different phases of the life of the
company. But, when you get to the time to become an IPO, suddenly,
especially with biotech companies that I looked at in Canada, you need to
have good answers to everything that was perfectly fine not to have answers
to until then.
So thinking of a biotech company that may have a product that is ready to
be commercialized or has been commercialized, has some sales somewhere
in the world – and let’s say was ten years in the making from the time, the
two days for ten years, nobody bothered me more than half the time, and you
guys are in my office for two weeks and are still not convinced, that is the
biggest thing of management.
MS. DELLINGER: We sort of touched on this, and my first point up on
the slide was, “issue or sale versus secondary sale.” I feel I would call it an
issue or sale. Basically a company sells its shares to a capitalist so that the
company then has more money to do whatever the company does. Usually a
good portion is used to pay down debt to the bank because the public market
is more flexible and cheaper money.
MR. PENHALE: Which in Canada typically happened to be the parent of
the underwriter doing the offering.
MS. DELLINGER: I read that, yeah, the relationship. Secondary sales
occur when you have a public offering, but the company isn’t selling a single
share.24 Rather, usually it would be a venture fund because the person is
management, and everything is locked up as the venture fund sells its interest
in the public market, so the company doesn’t necessarily walk away with a
penny. But the venture fund investor has now gotten significant liquidity by
doing an IPO.
That decision to do an IPO is going to be driven on to the venture-funded
company and in that example by the venture funds.
MR. PENHALE: As well as timing.
MS. DELLINGER: And timing, right. In the public market, it is a pickle.
There are also many situations where there is a hybrid, there is primary sale
of companies getting money to restructure the balance sheet and at the same
time some type of institutional investor selling shares to the IPO.
MR. PENHALE: Just a little anecdote in passing: the decision to become
public is also one where you have to advise the managers, the entrepreneur,
and the seller of the business that they are now subject to a fair amount of
scrutiny and transparency.
24
See generally University of Denver Sturm College of Law: Dialogue with Professor on
Capitalization, http://www.law.du.edu/wduong/Capitalization.htm (last visited on Sept. 27,
2007).
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By way of example, there was an interesting issue concerning a biotech
company that I was involved with. You can imagine you had people working
in labs all wearing white coats and the doctors and what not. Because it
involved farm hands, farm hands won’t typically command the same kind of
salary as your researchers or work on the same range of your projects.
As in any good business, there were discussions among employees about
how the researchers wanted more, and then the farm hands wanted more, and
I am not trying to berate what they did, but it was classic. Of course, there
was a good management reason for allocating more money to one individual
over another, especially if one is doing research and is going to create a
product while the other is taking care of goats. We prepared the prospectus
with a nice glossy cover, and it has a stapled back, not a glue back but
stapled, and the prospectuses are commercial copies that the dealer used to
market, and there is a certain amount of pride involved.
So when it comes off the press – and this is a preliminary prospectus in
Canada equivalent to your reds – boxes of it are delivered to the company
and management, including the president and chief executive officer, who is
a founder and is very proud to distribute this to all the employees to show
how good it was to have stuck around, to be part of a public company, and all
the pride that goes with the sense of success of your transaction.
Take that prospectus and sort of put it on your table, and let it open on
where it naturally opens. Guess what page it is? Compensation of the five
senior highest paid officers of which the one guy has been saying, “Oh, you
know, guys, I can’t pay you more,” and suddenly – he is not drawing
millions of dollars by any stretch but substantially more than the people he
was convincing that they shouldn’t take another hike in salary despite what
he was making.
Now, my point on that, and that happens and it is not law, but you have to
drop that point on to the person. Suddenly there is more transparency.
Another example would be a company doing perfectly well. They have a
process, have nice news, and they are in an environment that is competitive,
and suddenly they have to put out their financial statements. And lo and
behold, their customers are capable of basically figuring out what kind of
margins this company is making and what kind of product they are buying
from them. You look at what the competitor is selling them for, they realize
it is all profit and start to tell you, “I want a better deal.”
So yesterday your business was making, let’s say, $100 million dollars of
revenues and not particularly hard to do because you had good customers
buying from you, and today you have a hard time making $60 because all of
them retaliated, because they know how much you are making.
So that is to demonstrate that you have to be aware that you no longer can
keep secrets, and we are not talking intellectual property here. We are talking
what your business is, how it is, what I am paying you, the fact that you get
289
to fly on a company jet, how many times you want to do it a year, suddenly
your neighbor knows that.
MS. DELLINGER: And now it is disclosed as compensation with the
comp table.
MR. PENHALE: Right. The fact that you know you have got three houses
that the company pays for you, your neighbors know that or the fact that you
don’t, also. Maybe you are CFO of a company that never allowed you to get
those kinds of perks, and you live in a neighborhood where everybody thinks
you do.
MS. DELLINGER: Yeah. So I think both Anthony and I have indicated:
don’t enter into the IPO lightly. I think that’s the message there. One other
exit that I wanted to touch on – and I will not spend too much time on it – is
recapitalization. I always like to toss it out, and I said earlier, so often it is
easy to have people say, “Sell your business in sort of a commodity type
sale.” The recap is unique to every business. I call it the method by which the
entrepreneurial business owner can sell his business twice.25
It is sort of a hedging strategy, and there are different ways to do it.
Basically, let’s say you have a family that built the business from scratch,
good business, still has good growth potential ahead of it, the family may be
wealthy, but it is all part in the business.
The recap would be a way of basically being in, you know, selling a
portion of the equity. It could be 20 percent, 80 percent, selling a portion of
the equity of the company and keeping a portion of it to enjoy future
growth.26 So you are looking for a passive investor, some type of equity fund
if you are selling equity.
Another way to do it would be to layer the company up with a lot of
debt.27 Usually, the type of debt you would be looking for, you have to make
sure the balance sheet and the performance for the company can support debt
service, but the plan is that the entrepreneur pulls cash out of the business in
connection with some type of leveraged or equity recapitalization of the
business.
But they still own a good portion of the business and can still run the
business if they need to grow the business. Five years down the road maybe
they are ready for a sale to a private company or an equity fund or even an
IPO. At that point, they sell the remaining portion of it or at least another
25
See generally Barbara Pellow, Vertical Marketing: It Starts with Market Analysis,
available at http://www.ondemandjournal.com/specialfeatures/pellow59.cfm (last visited on
Sept. 27, 2007).
26
Beth Fitzgerald, Colleges Buy into Entrepreneur Classes, THE STAR-LEDGER, Nov. 10,
2004, at 50.
27
See generally Siseko Njobeni, Funds Still Biggest BEE Start-up Hurdle, FIN. TIMES
INFO. LIMITED: EUR. INTELLIGENCE WIRE, July 21, 2006, at 15.
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portion of the business and experience, you know, a second part of the
business.
The opportunity here, you get virtually cash out of the business earlier on,
and you don’t have all of your eggs in one basket.28 If the business continues
to grow tremendously and commands a multiple twice what you value the
recap at, you will be kicking yourself down the road when you sell the
second half and you realize $100 million, but now you realize it could have
been $400 million.
If the business gets eaten up in the market or has competitors coming out
of the woodwork and that performance in the second half as opposed to recap
is less than you expected, you may be thanking your stars. So it is something
that when I think I want to sell my business and, do you want to keep it, do
you want to let go, it is something very much worthwhile exploring. Not
every business can do one because it has to be something that you can layer
debt on. It has to have through the asset base, has to be attractive if it is a
leverage recap or has to have appeal to an equity fund, but it is something out
there worth considering.
MR. PENHALE: It also could be worth it to think about a situation where
you have, let’s say, two partners 50-50 and they don’t see eye to eye on the
direction of the business or what it ought to be. Sometimes coming in what
we would coin a thin ledge minority position puts a third player in. He gets
some money out, allows them to enjoy life a little more perhaps and maybe
also having a third person split some of that, well, I guess not seeing eye-toeye and using debt in that context, convertible debt or debt that is an equity
kicker can also prepare – further the interest in the business.
MS. DELLINGER: I want to make one comment on valuation in a
leveraged and a debt heavy recapitalization. It is almost as if you don’t have
to figure out the true enterprise value or equity value of the business in a
recap when you bring in debt because debt is going to look at pay me back
with the rate of return that I am looking for.
If they wanted to move, trying to estimate some type of return on their
equity, they want to get a good deal, but a debt is a fixed return instrument as
long as they can cover those, going to be an ability to pay it back, fixed
return and repay the principal. You can layer it that way.
So the true valuation, never going to be arguing about that, and that can
have some pros or can be sensed there is really no way of valuing it or not
prepared to hire an investment banker to do it, or you don’t think the market,
private or public, is going to respect what you think it is worth and this is
another option.
28
See generally University of Akron School of Business Administration: Entrepreneurship
Program, How to Get Financing, http://www3.uakron.edu/cba/fitzgerald/startbusiness/
financing/debt.htm (last visited on Sept. 27, 2007).
291
This is a little bit of a recap. Private sales, pros and cons, I think the pros
include flexible structures. The company can be very flexible post-sale and
not subject to the scrutiny we have been talking about.29 They are likely
faster to be put together than any type of public offering.30 No public
reporting.31 I am still in the limited shareholder group so you can still pick
the partners in a private sale potentially as a seller if you choose who is going
to be your buyer. Cons: there might be a lower valuation, I am not so sure.
You know, future management, strategic buyer, there may be some
displacement that goes on; access to future capital, not in the public market.
So if you want to go to public market for capital, you have to do an IPO at
that point.32 And probably the one that should have a star next to it, if you
sell your company at private sale and you roll over, an entrepreneurial
rollover the equity into the company, there is no public market liquidity,33 so
whatever shareholder agreement terms you have negotiated, that’s now the
terms you are going to be subject to for the next liquidity of the business,34
which at this juncture is not within your control.
Public sale IPO, I think we hit the points here. Pros include a potentially
higher multiple. Shareholder liquidities,35 a number of bells and whistles, but
it is out there. Continuing role for management, and you know once the
company is public, it does have access to both the public debt and the public
equity markets.36 The cons include public scrutiny, the lockouts, and you are
now subject to the whims of the market.37
MR. PENHALE: Yeah, you also probably tend to shift to a quarter view
as opposed to the longer-term view, or at least you have the pressure to do so,
which you never had to deal with before, just reporting and dealing with the
analysts. On the pros, perhaps a new currency. If you are going quickly or
sustaining growth, perhaps you can use your equity to finance that growth,
either by financing or by using it to pay the consideration of any acquisition.
29
Swapping Privacy for Growth, 68 CAN. & WORLD BACKGROUNDER 6 (May 1, 2003).
Id.
31
Id.
32
See generally Kristen Hays, Oil Vessel is Designed to Ride Out Hurricanes: Houstonbased Firm Going Public on Strength of its Innovative Platform, HOUSTON CHRON., Aug. 27,
2007, at 1.
33
See generally Fred Baldassaro, Economy, 144 A Surge Drives Private Market to Shatter
Record, CORPORATE FINANCING WEEK, March 2, 1998, at 1.
34
Id.
35
See generally Laura Slattery, Investors Deal in Shades of Grey as IPOs Loom, IRISH
TIMES, July 21, 2006, at 7.
36
See generally T. Prescott Kessey, Energy Finance 101, OIL & GAS INVESTOR, June 1,
2003, at 5.
37
Andrea Knox, High Costs Send Dupont Out of the Drug Business, PHILADELPHIA
INQUIRER, Dec. 15, 2000, at C01.
30
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Although perhaps with a little less relevance these days, maybe it is a
means to attract and retain personnel that you couldn’t afford to have
before.38 I say a little less because there are issues, options that we won’t talk
about, but it is still a way to align interest in your managers with the longterm growth and viability of the business.
The cons, one that does not appear on this list, there are costs to be public.
There are real-time resources and real dollar costs. If you pick up a
prospectus of any Canadian company in terms of the last five years, we did a
lot of income trusts. This was a booming business, and there is also a line on
any performer’s financial statements of administrative cost.
The average is probably a million dollars a year, some two, some 700 but
paying a million dollars is a lot of money every year to take off your top line
to pay to be public. Sometimes you don’t think about it, but it is a real cost. It
is not money you are generating.
I am happy because now I have been retained to help you in your
disclosures. I probably have the lead – the best interest in serving public
companies when they do disclosure stuff, but I am not a profit center for
them at all. I am a real expense. My tax partners are good because they help
them save money. I am just an invoice.
Why do I need to say this again? Why do I need to explain it five times,
and how many risks can you possibly think somebody would have to face for
an investor?
Nobody has thought of his or her business like that before, and there is
risk allocation between this is what you are not allowed to do. Now, they
need to worry about strike suits, or if I miss one quarter, what’s going to
happen? Somebody is going to sue.
MS. DELLINGER: Right.
MR. PENHALE: It is more prevalent in the United States than Canada
but nonetheless an issue.
MS. DELLINGER: In the U.S., obviously, you know, the legal fees
increase for companies dramatically, but that’s nothing compared to the
accounting fees under the new rules. So you have those issues. The equity,
you know, for finance that is newly public, an issue that came up pre-going
public, it would be: we don’t have to worry about that.
I know theoretically it is a risk, but nothing bad is ever going to come of
it, and you know, I am comfortable even if it will cost a few more dollars.
Now, they had that reaction, but then they go, “Oh, it is disclosable,” and call
their securities attorney and have to go through a whole analysis and get 17
other people in the company involved in discussing and deciding whether
38
See generally Kansas Technology Enterprise Corporation, Initial Public Offerings,
http://www.ktec.com/sec_business/section/erc/money/ipo.htm (last visited on Sept. 27, 2007).
293
they have an incentive in the prospectus or the 10(k) or the 10(q) about
whatever the matter is, and then they have to talk to the accountants in
protecting the reserve and numbers and financial statements about whatever
this thing that the business owner or the business CEO prior to the IPO never
would have cared about because he knew in his heart wasn’t going to be a
real issue.
So everything becomes a little more complex. I have a client that did a
public offering about a year ago, and now they just know they need general
counsel in the company, and they have a lead management team, the last
thing in the world they want but they know they need. So that’s the
consequence of the IPO from a mere perspective.
MR. PENHALE: And it is not a big issue, but sometimes it is. It breaks
your heart when you are an entrepreneur and think about it. In the recap, you
sell your business or maybe will sell it twice. Maybe the valuation has gone
down between the first and second time and so be it, and maybe it has gone
up tremendously.
And you say, “Oh, I never should have sold it at that price the first time.”
But you didn’t do too badly. The trouble with public companies, however
good you are, if you don’t have a big stake in it, you are really making
money for someone else. It is no longer for you that you are –
and suddenly you become a balance to all these people that have not done
anything in reality.
They just bought a piece of paper from you, and a lot of the accountability
I find is what entrepreneurs have a lot of hard time with. They talk to VCs,
talk to the angel. They talked to whoever was the money before, but it was
someone with a face and name and was a half dozen to dozen people.
It didn’t matter what, but they were someone with a name who they talked
to. But now it is the market. I never met the market, but I hear about it
everyday, and that’s also not to mention management earnings, quarterly
reporting, and the whole focus shifts from just one number four times a year,
and that’s how the business was managed before.
MS. DELLINGER: A lot of companies post their stock price in their
lobbies for all the employees to see. It is going good. It is a great motivator,
and employees have small options. But the stock is going bad, and there is
not a good explanation for it. It is transparent to customers and so forth, so
we sort of beat up on that point.
Recapitalization, again summary: a great opportunity for partial
liquidity.39 Have continuing investment in the company. Sell the company
twice. The complex structure, having it structured once you get the right
39
See generally BASF Chief’s Letter Makes Case for Offer Shakers Marketplace, INT’L
HERALD TRIB., May 24, 2006, at 3.
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partners in place. I put it under kind of hedge strategy, that’s a pro and con as
I discussed.
To the extent that it is a leverage recap, a company bringing on something
that is in debt potentially and debt services, by definition expenses, but, you
know, if you run a spreadsheet type show, rates of return on equity, there is
some point where debt dramatically increases the rate of return on equity,
and it is more important where it inflows. So the trick is to get that right
balance.
MR. PENHALE: You talked about debt a little bit. Now, you are dealing
with a bunch of covenants you didn’t have before. You know, if it is purely
financed on debt, you may have someone saying, “Hey, you got pretax with
X, and I am going to get the first slice of whatever you make.” And
suddenly, it may impede your ability to say, “What do I do in three months
time or nine months or three years time when I want to build my business
further, but I don’t have the pre-capital on servicing debt?” That’s also in
there.
MS. DELLINGER: Right. Liquidity drive, who makes the decision? To
the extent that the entrepreneur who grew the company on the back of
venture capital funding, the venture fund will more often dictate the time
line.40 Venture funds will say we looked it to be an investment two to four
years, two to five years, something like that.
It can be longer, but they are going to be looking for an exit, and that exit
either is to sell the company outright or bring in another round of venture
funding that does take out some of the old venture funds.
Second, whoever it is, however the company is structured, the majority
owners in a venture-funded company may be the entrepreneurs, but the
venture fund is really going to drive the timing.41 The family-owned
businesses, you know, the majority owners, at the end of the day can push the
buttons and make the decision.
The deal terms, to the extent that the deal terms of an entrepreneur raising
outside money dictated certain outcomes, quick rights, for example, on the
part of the shareholder, that may drive a decision to sell the company. And
then for non-venture-funded companies, basically market conditions, you
know, companies that make X right now are incredibly popular in the
market, it is a good time to sell.
I want to retire in three years. It is a good time to sell. Those can become
the driver’s on decision-making. Anthony, do you have –
40
See generally Getting Through the Initial Venture Capital Screen,
http://www.amplifiernetwork.com/tabid/93/ctl/ArticleView/mid/399/articleId/276/Default.asp
x (last visited on Sept. 27, 2007).
41
See generally Susan Schreter, Founding CEO Wants to be There at the Finish, Too,
SEATTLE POST-INTELLIGENCER, Dec. 2, 2005, at E1.
295
MR. PENHALE: No. Growth ultimately, the source of capital needs.
MS. DELLINGER: And this ties into the question you asked earlier.
When do you sell? How do you make that decision? Management equity, this
could be a long, you know, 17-hour discussion on tax. Luckily, Anthony, I
am not going to do that nor am I competent to.
But management equity, the entrepreneur equity in a growth company at
the time of the exit as we put it enjoying the successes of entrepreneurship,
you look for liquidity. For cash, you look for liquidity to pay your taxes on
the growth of the business. You look for liquidity to diversify your personal
investments if all your eggs are in the basket of the company, and there may
very well be an opportunity to continue investment options to continue to
grow with the business.
MR. PENHALE: I would add one point as well. At least in Canada, when
you are a private company, there is perhaps certain tax treatment afforded,
for example, with options that disappear and are less advantageous when you
become public or a certain transaction happens.42
So depending how you compensated your managers or the people you are
working with, they may have a nasty surprise as a result of the transaction.
So bear that in mind.
MS. DELLINGER: Yeah. And it is well before an exit strategy, and I will
get this on the last slide, as an entrepreneur and management of a company
you want to talk to and have advice from legal counsel and experienced tax
advisors prior to making – putting your pen to any piece of paper in
connection with the structure of this transaction.
One thing that is tossed out – and I am sure you have some comments –
equity rollovers. A deal comes to the table, the entrepreneur and management
say, “Oh, great. Buy my company, and put a little cash out and do a tax free
rollover.”
I will say this: nothing is ever tax-free; it is tax deferred. The tax will
always catch up with you, and the trick is to try to do strategizing whether to
pay the tax now or pay it later. I want to touch on taxable first and then hit a
couple things on the tax question. Taxable, taxable rollovers, what does that
mean?
Basically, the entrepreneur taking his or her options, taking his or her
stock, cashing it out and reinvesting some or all of that money in the
business, buying together with a new private equity fund, buying stock of the
company, taking some cash out and putting it right back in the company.43 It
42
TECHNICAL COMMITTEE ON BUSINESS TAXATION, REPORT OF THE TECHNICAL COMMITTEE
ON BUSINESS TAXATION (1997) http://dsp-psd.pwgsc.gc.ca/Collection/F32-5-1998E.pdf.
43
See generally Gary Klott, The Rules of the Game Have Changed: IRS Reform
Legislation Allows Greater Flexibility When you Convert a Traditional IRA to a New Roth,
CHI. TRIB., Sept. 15, 1998, at 5.
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can be structured a whole lot of different ways. You may never see a penny
of cash hitting the balance sheet, but you recognize the tax, and you realize
you pull cash out of that deal to cover the tax liability when it hits, which is
usually on, in the United States, April 15th following the transactions, or
there may be other taxes that are due.
You want to be very cognizant of that time period and, again, furnish
rolling money over, save enough of the cash you got out and pay the tax.
Tax-free transaction. As I said, nothing is ever tax-free.
MR. PENHALE: We generally don’t use the word “tax-free.” We say,
“No immediate adverse tax consequences.”
MS. DELLINGER: That’s what the lawyers think about it out there. We
have the investment banker selling something out here and have to be
flexible. In terms of any type of, you know, tax-free structuring, I will give
you an example: you have options in company A. Company A is being
bought by company B. You end up with options in company B, and you
think, “Great, I now have option to purchase stock in this new company that
is going to grow faster and bigger and have a lot more confidence, is going to
be dramatically more valuable going forward with more assurance of some
type of liquidity on my personal horizon.”
You want to consider a tax break and the timing of tax liability. A couple
of examples: tax break. You have a situation where right now, if you exercise
that option, you would owe tax on the spread. Let’s say the spread is $100
between the option to exercise price and the value. You know, your tax net
U.S. federal income tax rate roughly is 35 percent at the federal side and
close to 40, 42 percent with everything else.
You paid $35 on that, but now you own a share of stock in that new
company, and you experience capital gains rate on any additional
depreciation at roughly a 15 percent rate. You should be able to run through
some type of spreadsheets and projections and see whether you are better off
recognizing that tax credit now, having less money to reinvest in the new
stock because you paid your tax but then having future depreciation at a
dramatically lower tax rate.
Second, let’s say you have options. Your options are expiring. The
company is not selling. There is no liquidity event. You can exercise your
option. You roll it over into the new company. Now, instead of that $100, the
company has been successful, now let’s say that gain is $200. You have
another six months left to exercise the option.
The company is likely to have a liquidity event in two years. Okay. What
do you do? Do you let it expire and lose that $200 in value, or do you
exercise your option, not just for that one share, but for all the shares and
now have a very significant tax event but no cash because now you own
equity?
297
But you have no way of selling it because you don’t have a liquidity
event, and that’s being between a rock and a hard place. So I counsel clients
in any liquidity event, think long and hard about choosing to defer that tax
liability if you don’t have complete control on the ability to raise cash
concurrent with the timing of any tax liability, and think long and hard about
the tax rates.
Everyone talks about tax rates may change. They don’t change that much.
They have been in the same ballpark for a long time and fluctuate in margins.
Capital gain rates historically will continue to be in my prediction lower than
ordinary tax rates.
MR. PENHALE: And the same would be true in Canada with the added
nuance that, if we are talking private company as opposed to public
company, you may lose advantages or include it in the income deductions or
lose some capital gain, depending when that conversion would be done, and
that would be important to speak to your tax advisors just to make sure you
are not setting up yourself with the nightmare situation where you have no
cash and taxes.
MS. DELLINGER: I think the next slide covers what I crossed out before
and nothing new here, but you always want to be – management equity, you
want to think long and hard how you do it and look at the numbers, look at
the tax rates, run those numbers ahead of time, and don’t think tax free is the
way to go because it is definitely not tax free.
It is just a question of when. I guess the last thing I want to toss out there
– and these are a couple of U.S. issues – any time you’re dealing with
entrepreneurs, equity in a business, management equity in a business, any
type of exit, private company or public company – talk to that experienced
tax advisor and legal advisor. 409 and legal issues are what we call the new
“deferred compules.”44
Let me just say the summary that my law firm has done on this is enough
to fill a notebook this big, and that’s a summary. And all the rules and
regulations aren’t out yet, and it has been around for two years. So it is a
nightmare. Okay.
The 280(g) issues, these are references to the tax law.45 These are
payment concerns, and you think parachute payments, you make $50 million
a year and up, no? The standard is much lower than that, and then good tax
planning in terms of the tax effect on any potential tax shelter that might be
out there, it is something the tax consultant wants to think about.
MR. PENHALE: And if the deal only exists because of tax laws or you
have, more importantly, there is no reason to do any kind of transaction, you
44
See generally Claude Solnik, Another Glance from Big Brother, LONG ISLAND BUS.
NEWS, May 25, 2007.
45
See generally Executive Compensation, 61 EMP. BENEFIT PLAN REV. 12, June 1, 2007.
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want to look long and hard. At least in this, in Canada, it disappears at least
when the authorities look at it.
MS. DELLINGER: Whenever people get tax advice there are about three
levels of tax advice. One is: this is absolutely consistent with the Tax Code.
The second category is: it is a little aggressive. It is an audit risk. If you get
audited, it could be challenged. It could be restructured, and X, Y, Z could
happen, which would not be quite as favorable as what we are hoping.
The third category is what I call tax fraud. You simply can’t justifiably
take that position and file your return, but if you are caught, you are in big
trouble. I think that sort of comes under the tax plans.
MR. PENHALE: You have nuances like will, should, could. You have
got a filing position but no chance in hell to succeed. Best aspect is to ask the
tax advisor for the glossary and what they mean in their opinion.
MS. DELLINGER: Those are all really sort of semi-prepared remarks. I
would like to open it up for questions.
MR. PENHALE: Just before you do so, I would just draw one comment
on going public. Don’t forget, at least in Canada, you are going to become
liable for what’s in the prospectus, and much like in the U.S., also, we have
secondary market liability.46 So whenever you add a sentence in the public
disclosure document that you thought was great when you put it in the
confidential memorandum and you are trying to put your company in the best
light possible, they don’t have to even show they read it, that they relied on
it.
It is in the book and they relied on it, then you are liable if it is a
misrepresentation. It is a long, hard exercise before you start going public, or
once you are public, pay attention to what you are saying because it may be
wrong, and if it is wrong, it may cost you.
PROFESSOR GORDON: I would like to open it up for questions.
MR. PENHALE: Yes.
DISCUSSION FOLLOWING THE REMARKS OF ANTHONY PENHALE
AND ELIZABETH DELLINGER
MR. GROETZINGER: What’s your thought on earn net clauses if a seller
has a business and neither party can agree on the current fee price and agree
on some downstream multiple of earnings? What would you recommend?
MS. DELLINGER: I think they are great. I think that if you have a
company and you have a willing buyer and seller but can’t just get together
on price and earn out a wonderful way to bridge that gap and align the two
interests, that being said, there are a couple of nuances.
46
Gloria Gonzalez, Quebec Latest Province to Mull Corporate Disclosure Law, 41 BUS.
INS. 31, July 30, 2007, at 4.
299
One, they always are and they should be heavily negotiated because you
really got – they are tying to the performance of the company, and you really
need to tie down what everybody needs. For example, the line of business is
sold, and if a business is bought into the company, how does that impact
you? What do we really mean by net operating income? And really drill
down and have a lot of detail in what that means, whether it is on a schedule,
a separate document, purchase agreement, wherever, but get a real clear
understanding of what’s intended.
Second, they frequently litigate. Of all the things that get litigated in a
purchase agreement, earn-outs and working capital adjustments are probably
the two biggest ones, so you have to be prepared for that. Have more clarity
upfront.
Litigation usually happens not because someone lied but because
somebody didn’t have the advice. So the more work done upfront, the better.
You don’t see it all the time, but I tend to be a fan if you have a good deal as
having purchase price issues.
MR. PENHALE: I think you can bridge that issue, and just to reinforce
Betsy’s point, those I have been involved in two lines of agreement, by the
time all the advisors were through nobody understood it, and it was two or
three pages, and then we show the end result. And they told us that just
doesn’t work so implementing them, making sure they are going to get the
results you want and making sure if you don’t get what you want you can’t
actually have a leg to stand on to demonstrate what it was you thought you
were going to get. That’s not as simple as saying why don’t I just bridge that
value gap.
MS. DELLINGER: I have had several occasions where we started
negotiating the earn-out net drives, and that’s so painful for the party on the
purchase price.
DR. BARBER: I realize in your presentation you were expected to talk
about capitalizing on results of IPOs and private sales and things like that and
the impacts of tax and so on. But I thought you might comment as well on a
successful company paying dividends. That’s another way of capitalizing on
success.
MR. PENHALE: Yeah. I touched on income trust earlier on, and this
filled a need in Canada for high dividend paying corporations. In fact, that’s
what they were. I don’t remember the exact statistics, but with the Canadian
companies that are listed in the TSX, a staggeringly low percentage pay any
kind of real dividend.47
I mean, they pay a dividend perhaps banks and telecoms, but anything in
excess of five percent, I think I would be impressed to find one more
47
See Definition of Terms, GLOBE & MAIL: REP. ON BUS., June 29, 2007 (“Recently, the
average dividend yield of companies in the S&P/TSX Equity Index was about 1.67%.”).
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[Vol. 33 No. 1]
depending on time of year. So as a venue for an investor, at least in the
Canadian market, you are not going to get any real dividend. You may have
some private shares but, ultimately, not the type that one would look to get
the return on that income trust in Canada, which were paying anywhere, the
best company seven percent. They were not so great at 18 percent.
They were great investments from that perspective, but we don’t have the
equivalent. We thought when the government announced they were going to
tax these corporate entities now, we thought that one of the things that would
happen, in fact, would be that they become great targets for U.S. private
equity to buy them and spin them out in a couple of years in the U.S. market
as a high dividend paying stock.
DR. BARBER: But that’s normally after you have done an IPO.
MR. PENHALE: You could.
DR. BARBER: And I am saying, I know private companies that paid out
a big lump dividend.
MR. PENHALE: You could accomplish that with your cash on hand on
your profit or using a lead account, increasing level of debt and using the
debt to do that.
MS. DELLINGER: I was going to say I had two or three categories; one
company experienced growth. It is not looking to reinvest tons of money
because it is very stable and a very comfortable business.
The money just flows out and sort of not well known because it is a
privately held company, but the family, everybody is driving better cars.
Everybody is wearing nicer clothes, and oftentimes one of the relatives is
doing the payroll. It is a great way for an entrepreneur to amass personal
wealth, and you can do that, and you still would have the business.
It is sort of like selling the business twice. It is sort of like a recap without
the recap in some respects. You bring a lot of value out of the company. A
recap is often structured with dividend, but that’s really structuring
technique.
One real life example of ours – and it is a public company now so if
anyone wanted to backtrack, they could probably find it, that it is public,
founded by a couple of guys around 1990 who grew the company, did it a
number of times, sold it to an equity fund, the equity fund sold it to a new
equity fund.
Every time management pulled out millions of dollars and then rolled
equity back in, and they did that three times. Then this was the same
company that the year 2006 did an IPO. However, three months before the
IPO, the equity fund – that equity fund pulled out a $200 million dividend.
Management’s equivalent share resulted in about close to a hundred
million dollars in dividend coming out for management. Then three months
later they sold the IPO, and everybody pulled out a bunch more money in the
IPO with the equity fund selling completely on the secondary IPO.
301
You know, so dividends are a good way of getting money out of the
business. You make yourself a lot of money, running a lot of – not that it is
permitted, but the number of expenses, business expenses – in fact, there is a
lot of value channeled through that.
MR. PENHALE: On dividends and just anecdotally, I am involved where
there is 50-50 shareholders, founded a company 30 years ago; in its great
days had about $600 million of revenue. Now it is about $225. I have been
involved with IPOs now for almost four years, and the purpose why I am
involved is because they cannot agree on what they want to do with the
business: buy it, sell it, refinance it.
It is a great business to go public with, but it is paying out between $50
million to a hundred million dollars a year. The only reason none of them
have done anything in terms of litigation, they really don’t like each other,
and it is amazing from my perspective this business can still generate the
numbers it does when two guys who are running it supposedly because they
are not really running it, they are bickering and fighting, are not involved,
and you sit back and look at my counterpart on the other side and say why
are we here?
Every year they pay themselves a hundred million-dollar dividend. If they
weren’t fighting and arguing – their managers are running it. They are just
going to make plus or minus $10 million more. Why are they arguing? Why
are we here? Four years in the making, and they were paying each other
dividends way before we got there. They don’t talk to each other any more.
They just get their check and go away.
PROFESSOR GORDON: Before we thank the panelists, I just want to
mention that cocktails start at 5:30, and I guess dinner is at 6:30.
And I thank you all for today. Thank you very much, panelists.
169
ENTREPRENEURSHIP: BUSINESS AND GOVERNMENT
Session Chair – Charles Magerman
Speaker – Hon. Eddie Francis
INTRODUCTION
Charles Magerman
MR MAGERMAN: Good evening. Sorry for interrupting the dessert
portion of the meal, but can everyone in the back hear me? Is the microphone
working back there? I don’t know. Thank you. It is working? I am getting
nods from the back, so I think it is working.
If you haven’t met me already, or if you weren’t paying attention when
we met, my name is Chuck Magerman, and I practice corporate and finance
law with Baker & McKenzie’s Toronto office, where I head up the corporate
finance practice group in Toronto.
I have been asked, and it is my pleasure to be here tonight, to introduce
the Mayor of Windsor, Eddie Francis, who will be making comments to you
about – I don’t want to steal his wind – but about entrepreneurship and about
government and the relationship between the two.
If you haven’t read the bio in the book, I may add a little bit to that.
Francis was elected as a councilor in 1999 in the City of Windsor, and he
was the youngest ever elected at age 25.1 You can do the math and figure out
how old he is now.
He was re-elected as a councilor again with the largest majority ever in
2000,2 and you may wonder why was he elected in such a short period, but
the 1999 election is a by-election.3 And then he was elected in May 2003.4
After he was elected as a councilor, he entered law school at the University
1
Speaker Biographies, University of Michigan: Ford School of Public Policy IPE 2006,
http://sitemaker.umich.edu/ipe2006/speaker_biographies (last visited Oct. 19, 2007).
2
Id.
3
PM Calls By-Election in Windsor-St. Clair, CBC NEWS, Mar. 7, 1999, available at
http://www.cbc.ca/canada/story/1999/03/07/windsorbyelxn990307.html.
4
Biography of the Mayor, The City of Windsor, http://www.citywindsor.ca/000087.asp
(last visited Oct. 19, 2007).
303
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[Vol. 33 No. 1]
of Windsor, and he was called to the bar and belongs to the Law Society in
Canada and here in Ontario.
Before politics, however – and this is what makes him especially qualified
to speak to us this evening – he, together with his brothers, successfully built
a pita bread company that grew. This is Royal Pita that grew and was
distributing to twelve states and various parts of the province.
And I think he is going to tell us a few stories about that and his
experience with that business. And you may want to know one of the
questions we were dealing with this afternoon is when do you decide when it
is time to sell, and when do you know when it is a good price, at what
multipliers. You can get into that if you like, Mayor.
So the question is: will he be talking to us tonight about entrepreneurship,
business and government as the topic reads, or will he be talking about
entrepreneurship leading to government positions or how entrepreneurs can
access government funding?
We have many choices, but I leave it to the Mayor, and I welcome you.
SPEAKER
Hon. Eddie Francis∗
MAYOR FRANCIS: Thank you, Chuck. Thank you for that kind and
warm introduction.
And I have got to admit right off the bat, as a politician, having someone
copy each and every single word makes me nervous, but it is good to be here.
And part of my discussion this evening will be a discussion focused on,
obviously, entrepreneurs, and given my position as Mayor of the City of
Windsor, how entrepreneurs play a role in the government if it does have a
role to play at all.
But first and foremost, I would like to recognize and thank Henry for
having me and inviting me here. I know that you had a great couple of days
of discussion, and it has been a great program thus far. Now, it is odd for me
to be standing here, and I told my wife I was going to be here speaking to
∗
Prior to entering politics, Mayor Francis ran and operated Royal Pita Baking Company.
His operation’s distribution quickly grew to include Ontario and 12 U.S. states. In 2003, he
was awarded the Windsor Chamber of Commerce Business Excellence Award as the Young
Entrepreneur of the Year. Mayor Francis graduated from the University of Windsor Law
School in 2002 and articled with Miller, Canfield, Paddock, and Stone. Subsequently, Francis
was called to the Bar of the Law Society of Upper Canada. Mayor Francis also holds a
combined Honours Degree in Chemistry and Biochemistry from the University of Western
Ontario.
Francis—Entrepreneurship: Business and Government
305
each and every one of you. Here you have an individual that was in private
business as an entrepreneur, then became a lawyer and ended up in politics –
eating chicken dinners and spending long hours and low pay that attracted
me to politics. And I told her there is going to be a group of lawyers, and she
said, “Good. Get one of them to represent you to sue you for being a fool to
go into politics.”
To give you some background in terms of how it all became possible for
me to represent the City of Windsor – which is a true honor, something I
enjoy every single day – I attended the University of Windsor Law School,
and I did my undergrad at the University of Western Ontario.
Doing my undergrad at the University of Western Ontario in chemistry,
biochemistry in my fourth year, I had intentions of going into practice and to
research. Growing up in high school and grade school, I was a student of the
sciences, and that’s why I did biochem.
But my parents had emigrated here from Lebanon in the early 1970s; and
they immigrated to Windsor. My father, after putting in his time in KelseyHayes and some of the plants, he was trying to find a meaningful way to
make some money and raise a family, and he discovered there was something
that was missing in the Southwestern Ontario area.
There is a large Arab population, both in Southwestern Ontario as well as
in Michigan and even in Ohio.5 But all of them were still making bread in
their own kitchens and their own ovens. So my father established the first
pita bread operation in Southwestern Ontario in the early 1970s, and he only
catered to the Arab population because that’s all he knew.
In the 1990s, he decided to retire. Here is an individual who worked 16
hours a day, seven days a week, and he decided to retire. He had no hobbies;
he knew nothing else but to work. Growing up, we grew up in the family
business, so when we wanted to see our family, we went to the family
business to see them. When our friends were doing things on the weekends
or having parties or taking in extracurricular activities, we were growing up
in the family business doing what we had to do as part of our responsibilities.
So he retired for two years and then decided to get back into it in 1997 as I
was deciding where my future career was going to be after my undergrad.
He bought the building. He bought the machines. He was about to get
started again, and then he fell ill. So I was asked, being the oldest, to come
down and run the family business. I thought it would be a summer job, which
5
See Federal Electoral District Profile of Windsor West-Windsor-Ouest, Ontario, (2003
Representation
Order),
2001
Census
Map,
Statistics
Canada
http://www12.statcan.ca/english/census01/products/standard/fedprofile/RetrieveTable.cfm?R=
FED03&G=35102 (last visited Oct. 19, 2007); G. PATRICIA DE LA CRUZ & ANGELA
BRITTINGHAM, THE ARAB POPULATION: 2000, 4 (U.S. Dept. of Com. 2003), available at
http://www.census.gov/prod/2003pubs/c2kbr-23.pdf.
171
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[Vol. 33 No. 1]
was great. And growing up in the family business is not that hard, right? I
grew up in it. It seemed pretty easy. The machines did everything, and the
workers were there, distributed the product. It was just flour and water, and
the rest is simple. After all, for years he had been making a living doing this;
he had taken care of us, raised three kids, and provided for us. It can’t be that
hard.
So I decided to come down, take a summer leave, graduated from
Western, decided to come down and run the business, and that’s when I
discovered something. I discovered that, although my dad was very good at
what he did, my father was very smart at what he did. He only catered to one
aspect of the market, and that was the Arab market. You can’t blame him for
it because he did a good job.
So my brothers and I decided that we could take this to the next level.
And again, that was 1997. This is 1998. This is before the Atkins diet. This is
before the carb craze. This is when people were starting to discover pita.
McDonald’s even had pita on the menu.6 Subway was getting into
flatbreads.7
When I went to school, when I was growing up, I was the only kid with a
rolled sandwich where everybody else had these thick-layered Italian
sandwiches. Nobody knew about pita growing up. But in the late 1990s,
when we decided to get into the business, everybody was starting to discover
the health consciousness and the understanding in terms of what pita was.
So my brothers and I wanted to exploit that. We wanted to take it to the
average citizen. We wanted to take it to the Canadian and American
marketplace, outside of the traditional Mediterranean-Arab marketplace. So
we said we are going to do that. So we got the business.
We started running it, and we ran into a couple of problems. Back then,
when we first started – I was 22 years old, my next brother Roger was three
years younger, and Frank was 16 years old. We ran into some problems.
Growing up in the family business wasn’t as easy as it appeared to be. We
couldn’t find anybody to supply us with our raw materials. The flour
companies did not want to give a group of young guys a credit line. They
didn’t even want to supply us with product. The banks didn’t want to give us
money.
We were going to make a pitch to the Costcos, to the Sam’s Clubs, to the
Wal-Marts, to the retail markets. A 23-year-old kid sitting across the table
6
But see David Leonhardt, McDonald’s Can it Regain its Golden Touch?, BUS. WK.,
Mar. 9, 1998, http://www.businessweek.com/1998/10/b3568001.htm (stating that Wendy’s
was using pitas as a way to compete with McDonald’s).
7
See Bruce Horovitz, Subway Wraps Up Deal With Atkins, USA TODAY, Dec. 25, 2003,
available
at
http://www.usatoday.com/money/industries/food/2003-12-25-subwayatkins_x.htm.
307
from you, you are not going to take him too seriously. You are not going to
give him shelf space in your retail establishment, especially with all the
competition.
So we came up with a pretty innovative product mix. What we did was
we were going to take pita bread to the next level in the sense of recognizing
that it was not a specialty product. It is only flour, water, sugar, salt and
yeast. You go to the store and buy a pack of five of pita bread, it is like four
dollars. It cost us 30 cents to manufacture and produce it. Yet, people were
still selling it at four dollars, and that’s because people were treating it as a
specialty product. So we said we were going to go with a product that was an
accurate reflection of the cost. We were going to market it, fresh every single
day, and produce the product and get the pita into the stores.
Again, to go back to my original point – we didn’t even have the flour. I
couldn’t get the flourmills to supply us with flour. So we approached Costco,
and we said to Costco – you have all been at Costco, right? You know
Costco sells flour? So we said we are going to go to Costco, and we are
going to say to Costco, “We need some flour. Will you supply us?”
And in return, we are going to ask them to carry our product for us. So we
went into Costco, we scheduled a meeting. It was the biggest meeting ever,
again I was 23, 24, right? Put on our best suits. This is our first pitch we ever
made, and we go to Costco and said to Costco, we are owners of Royal Pita.
We want to buy flour from you. In return, we want you to carry our product
in all of your stores. We want access to all of your stores, and I am going to
guarantee that we will buy flour from you. Costco said okay, sounds good.
How much flour do you guys need? I said one bag a month.
That was exactly their reaction.
I said to them, though, give us a chance, and I promise you that bag will
turn into something larger. Within a matter of months, Costco let us in. We
got access to their stores. Within a matter of months, we took that one bag
and turned it into 22 tons of flour a week.
Because of Costco we were able to get into other retail outlets, and
because of that, we grew on that same type of formula. And from the very
day that I started till the day I sold my business, Costco was the only supplier
of flour to our business, although the other flourmills started coming around.
We used 22 tons a week.
We grew up on the same type of premise – whether it was in Windsor,
Ontario; in Detroit, Michigan; in Toledo, Ohio; or in Atlanta, Georgia – we
went in with the same type of philosophy. We are going to provide you with
the best product there is at the best price.
And what we were able to do from a Windsor location, from a Windsor
plant, was produce 7,000 packs an hour, ship them down to Atlanta in less
than 24 hours and out-compete the bakeries that were in the Atlanta area.
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I could get my product – anybody from Atlanta here? Farmer’s Market?
Are you familiar with Farmer’s Market? I could get my product to Farmer’s
Market quicker and cheaper and in better quality than the bakery around the
corner could, and that –
(Applause.)
Thank you.
But it just didn’t happen overnight. And I will never forget how we
started because when we were doing the first Costco lines, remember we are
a new product and showed up with four or five bags. We were delivering in
our Ford Escort backing up into loading docks with these big competitors,
right? You got the Westins and the Dempster’s in Canada.8 Here you have
different Wonder Bread companies that distribute.9 So these guys were
backing up and piling up stacks and stacks and stacks of trays of bread, and
we are just walking in with four packs of bread, and we knew we were going
to out-compete them. But that’s the prize of entrepreneurs, and that’s what
you have heard over the past few days – an entrepreneurial spirit that gets
you up and wants to make you compete and makes you want to do better.
That’s the same thing that led us to get involved in Royal Pita and also led
us to get involved in our community. Royal Pita in Windsor, I got involved
in the community. I will never forget, I was at a wedding a couple months
before we opened Royal Pita, and we opened up Royal Pita on a street called
Wyandotte Street. Wyandotte Street traditionally didn’t have a good
reputation. That’s where all the drug dealers were, where all the hookers
were, the prostitutes. That’s how we got a good deal on the building. We
bought the building with the vision that once we buy this and establish this
business, we were going to be able to turn around the entire community.
And the wedding I was at, I remember someone asked, “What do you
do?” and I said we were about to start a business. They asked where I was
located, and I told him, and just like the people at Costco, they laughed. But
we got involved in our community through our business. By one
entrepreneur locating on a desolate corner that others would not even pay
attention to, it served as a catalyst for other entrepreneurs to do the same
thing, because it only takes one. It always takes that first person to lead to the
other investment, for others to follow.
I am happy to report, today Wyandotte Street is a whole different street.10
In a matter of six or seven years it is now known as Mediterranean Row.11
8
E.g., Dempster’s, http://www.dempsters.ca (last visited Oct. 19, 2007).
E.g., Wonder Bread, http://wonderbread.com/index.asp (last visited Oct. 19, 2007).
10
See A Closer Look at Wyandotte Town Centre, NEWS LETTER (Wyandotte Town Centre
Bus.
Improvement
Ass’n,
Windsor,
Ont.)
Oct.
2007,
available
at
http://www.wtc.cc/wtcpage1.htm.
11
Id. See also Business and Retail Zones: Zone 1 – Wyandotte Towne Centre, Windsor9
309
You have tons and tons and tons of storefronts that have been filled now by
immigrants that, otherwise, would not have filled them –
from bakeries to retail stores.12
So what happened was, in 1999, as we were doing that, as we were
developing that, we got involved in the community, and we were fortunate
enough, my brothers and I, to be recognized by the Chamber of Commerce. I
recognized my brothers because they still give me grief, to this day, because I
take all the accolades – but we were recognized as “Young Entrepreneur of
the Year,” and that was in February of 1999.13
In June of 1999, there was an opening on city council and there was a bielection that was open. This is a true story. Because of the profile that was
gained through the “Young Entrepreneur of the Year” award and our work in
the community, I was on my way to do a product pitch, and I got a call from
a reporter at The Windsor Star.
She asked me if there was any truth to the rumor. And I said, “Truth to
what rumor?” She said, “You are running for Windsor City Council.” I said,
“Excuse me, who are you again?” She said, “My name is Granell – my name
is Margaret Granell from The Windsor Star.” I said, “I don’t know what you
are talking about. Thanks, good talking to you.” That was it.
Next day in The Windsor Star there was my picture with 15 others
“Rumored to Run.” Well, I thought about politics, but I never thought about
running for politics. I was 25 at the time. I just applied to Windsor Law
School and just received my acceptance into Windsor Law. So my career was
to go practice law in the City of Windsor, go be a lawyer and contribute to
the community.
But then, it happened again – same thing that I experienced growing up,
the same thing I had to deal with starting Royal Pita – goes back to people
not leading young people, they are not investing in young entrepreneurs, and
I started to hear that he is good. And so I decided to run, and fortunately for
me, we put on a strong campaign.
My campaign team was a campaign team of three: myself and two other
brothers. The business suffered those couple months, but we put on a strong
campaign, and we were not supposed to win.
But then, fortunately, I was elected to represent Ward 5,14 which is the
east end of Windsor. I wanted to apply what I learned through the business to
Windsor Council, and I did that, but at the same time I went to law school.
And then I became a lawyer, and I had a decision to make.
Essex County Development Commission, http://choosewindsor.com/source/html/comm/
zone01f.htm (last visited Oct. 19, 2007).
12
Id.
13
Biography of the Mayor, supra note 4.
14
Speaker Biographies, supra note 1.
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The decision I had to make was whether I was going to be a lawyer or
whether I was going to be mayor of the City of Windsor. My wife and I
decided to go away for a vacation, decided to have this most important
discussion while we were away, and I had made my decision.
I had four years under my belt as a political representative. Politics is
interesting to say the best. It is not for everyone. My hats off to those
individuals that can do it, that do it extremely well and do it consistently, but
politics is a different sport. It is a different environment than in the business
sector. It is different.
And I didn’t expect it to be as different as it was. So the decision I had
was: I wanted to go and practice law. And my wife looked at me and said,
“That’s fine. I am 100 percent behind you. I will support you in any endeavor
you choose to undertake. But know this: if you decide to walk away, no
‘what ifs,’ no complaining, no watching councils, no sitting on the sidelines,
no Monday-morning quarterbacking.” And then she said, “You know, you
could be a lawyer any day. You can’t be Mayor of Windsor any day.”
So I decided to run, and the reason I decided to run is because the City of
Windsor – how many of you have been to Windsor? How many are from
Windsor? There is always a connection. Thank you.
Windsor is an amazing city, and I am not saying that because I am the
mayor. It is an amazing city because of its history, because of its location,
and because of its potential. Here is a metropolitan area – 350,000 – and
when I decided to run for mayor, I was facing some critical issues, and those
critical issues would certainly set its course in what it would be in the future.
So I saw that as an opportunity to contribute. I wanted to bring my
business background, my business acumen, I wanted to bring my experience
to change the way things were traditionally done because it always seemed
that it was going one way. So I decided to run for mayor, and one of the
things I decided was to run on a platform with the same entrepreneurial spirit
that carried me. And that spirit was a success for me and my family through
the business, and that is: work hard, know what it is you are trying to
accomplish, set out the plan to accomplish it, and go and do it – very simple.
But I was 29. People don’t elect 29-year-old mayors. They don’t, right?
So that was the biggest challenge. I was running up against strong
competition, years and years of experience on council. But I set a very
specific plan. Just like in business, this is where we want to be. We want to
be a city that is thriving, a city that is dynamic, a city that is diverse. That is
how we are going to get there.
So I started off by mapping out the same thing you do when taking over a
business that is going in the wrong direction. You have to get your financial
house in order, right? You can’t do anything if your financial house is not in
order. So I set out, and I said in my campaign platform that I was going to
reduce the city’s debt by $40 million.
311
Our long-term debt was projected to be about $272 million by the end of
2006.15 So I said for my term in 2003, I was going to reduce the debt by $40
million. People looked at me and said there is no way you can do that. It is a
ploy. It is a promise. No way. They were right. We didn’t reduce it by $40
million; we reduced it by $115 million in our three-year term.16
Then we focused on making sure that we had the solvent infrastructure
that we needed in place. And one of the most critical things that Windsor had
to deal with, if you don’t know, is that Windsor is in a strategic location. It is
the most important and most valuable crossing point in North America;17
crossing through the Detroit-Windsor border.
And 28 percent of all trade is between our two nations, Canada and the
U.S., and crosses through that gate, $150 billion.18 It is explosive trade that
has taken place over a series of years because of all the trade and the
explosive things that have taken place. But it is trade that has taken place on
infrastructure built by our grandparents.19
And one of the things that you do in business, and that we did in business,
in our own business, and that entrepreneurs do all the time, that is, we invest
in the business. You reinvest in the business and make sure you have the
proper tools and proper equipment to produce a greater product. Why can’t
the same thing apply to government?
So the biggest challenge we had – we knew we needed a bigger, better
infrastructure. Long before we started talking about infrastructure as a way to
improve productivity in Canada and the U.S., the Chinese and now other
Asian countries and India and all of them have been pouring millions and
millions and billions and billions of dollars putting their infrastructure in
place, long before anybody knew what they were doing. They were creating
the critical supply chains, long before anybody knew why they were doing it.
Today with the situation in North America, our ports, they are under extreme
pressure.
15
Compare, Eddie Francis, Mayor, City of Windsor, Chamber of Commerce Mayor’s
Luncheon Address: Building a More Competitive Windsor, at 3 (May 31, 2006), available at
http://www.citywindsor.ca/documents/CouncilServices/Mayor/BuildingaMoreCompetitiveWi
ndsor.pdf (stating that at that time the debt was projected to be at $276 million by the end of
2006).
16
Biography of the Mayor, supra note 4.
17
See Monica Davey, Bridge’s Private Ownership Raises Concerns, NY TIMES, Oct. 12,
2007,
available
at
http://www.nytimes.com/2007/10/12/us/12bridge.html?ex=1349841600&en=1142494dabdde9
01&ei=5088&partner=rssnyt&emc=rss.
18
See id.
19
See
e.g.,
Construction,
Ambassador
Bridge
–
History,
http://www.ambassadorbridge.com/history/construction.html (last visited Nov. 29, 2007).
174
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[Vol. 33 No. 1]
The critical supply chain between Detroit and Windsor is still trying to do
things the way they used to do things 75 years ago.20 So the border was a key
issue for us, and that’s something we have been working towards and trying
to work on.
I use that as an example in terms of where entrepreneurs can go. The
private sector doesn’t apply in government. In business, you invest in the
infrastructure and get it up to speed, and you make it happen. In government,
it has been now – how long, George? I have been there for about seven-anda-half, eight years. I started there talking about the border, they are still
talking about the border, and that has been the difficult challenge for me.
That’s why I said earlier that politics is different than business. Politics
has a way of really providing you a different perspective in terms of how to
get things done. In business, you know what needs to get done. You get it
done. In politics, you know what needs to get done; you can’t get it done
until you get everybody else on the same page, and that takes years and years
and years.
I will give you an example: the most important things that we are dealing
with, that I know you are dealing with in all cities in all regions in terms of
time, from your areas in the cities – how many by a show of hands have all
the support and everyone on the same page? By a showing of hands, how
many economies are rich?
The way things used to be done, the way that companies used to locate in
a city, the way that companies used to locate in towns, the old paper mills
would come in, the flour mills would come in, the lumber mills would come
in, and when they came in, they would locate and invest in it, and people
would follow. People would always follow the jobs.
That no longer is the case. Today’s global market, where technology and
capital is shifted around the world at the push of a button, it is no longer
people following jobs; it is jobs following people. That’s where it becomes
important for us as politicians and leaders of a community to recognize
where the entrepreneurial spirit needs to be at play. Recognizing the change
in the trend is important in terms of securing ourselves and moving forward.
People are now choosing where to live based on quality of life, and where
the people are, the jobs are going to follow.21 And this is where it is
extremely important because our ability to compete as a city in Canada, or as
a city in the United States, is primarily going to be driven on our ability to
innovate, in our ability to come up with ideas because nobody else can
20
Davey, supra note 17 (stating that the Ambassador bridge is almost 80 years old); see
also Construction, supra note 19.
21
See Alexander C. Vias, Jobs Follow People in the Rural Rocky Mountain West, 14
RURAL DEV. PERSP. 14, (1999) available at http://www.ers.usda.gov/publications/rdp/
rdpsept99/rdpsept99c.pdf.
313
compete with us there. Everybody else can produce the product, but not
everybody can come up with the idea to produce that, right?
So how are we going to attract people to our cities? Because we need to
attract these people to our cities. If they come to our cities, if they are living
in our cities, if they are raising their families in our cities, then they are going
to be coming up with the ideas in our cities.
If it is our cities that are coming up with the ideas, then we are going to
have to do competitive damage as we compete with other global forces. The
first thing we need to do is recognize that it is no longer city against city, city
against town, or neighbor against neighbor. It is region against region, and I
am happy to report that government is final getting that. I think it maybe is
two, three years too late, but I think they finally realize that they have to
work together.
And I think the governor of Michigan uses a very, very good term in
terms of describing that, and that’s cooperation. And the cooperation that
they use instead of the competition that used to be in place is now forcing the
cities and towns to work together. So when I talk about Windsor’s region, I
include Ohio in all my discussions. I include London, Ontario. I include
southwestern Ontario, southeastern Michigan, and the Ohio District because,
as one region, we are powerful.
And what we have to do is send a message – just like we do in business –
send a message, we are competing with other customers, right? We are
competing with other companies to attract those people but sending the
message to attract people to live in our cities because we are investing in a
quality of life.
So now it is no longer at the municipal level talking about roads and
sewers. It is talking about the arts and cultures, talking about the parks. It is
talking about the amenities, talking about the facilities we have involved,
because we want those people to come and live in our region.
One of the greatest examples we use is the Detroit-Windsor example. I
am perhaps the only city of my size – I don’t have professional sports teams,
but a five-minute drive across the river, I have got access to all the
professional sports. So by attracting those people to live in our city with
those amenities gives us an advantage.
And the advantage is how do we take those people, and how do we tap
into their ideas? And that’s where the universities and the colleges and all
these institutions come into play. That’s where we come into play, and that’s
what you heard over the last two days. How do you foster that
entrepreneurial spirit? How do you take those entrepreneurial ideas and turn
them into product? It is that support mechanism that is required to turn it.
So if we can attract people as cities, we will do our job; we will make our
city so livable, create so high a standard of a quality of life that they will
come. They will raise their families and will come to live in our cities. Yet,
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the issue then becomes what is going to be the support network to take those
ideas, to turn that routine to product?
The university and colleges play an extremely critical role. Business is
playing an extremely critical role. The problem we have at the city municipal
level is that we cannot provide them with the type of incentive that they can
live with. That’s going to have to come from senior orders of government or
from another type of collaboration that could take place between the
institutions and the companies. That’s the key.
On the American side, they are fortunate. On the American side, you have
more access to that level of funding, that level of support, than we do on the
Canadian side. I remember a story when I was growing up and doing our
business, I was collaborating with a business in Boston, and I called up the
owner.
And I said to her, “What are you up to, you know, we have got this
customer and supply.” She was on her way to the White House because she
had received funding in the form of a grant to invest in a new line of
manufacturing. She had the opportunity to find something.
Today we have, in Windsor, the Auto 21, the ARDC Center and the
University all collaborating with each other.22 Chrysler, GM and Ford, they
are collaborating with each other.23 That level of collaboration, that level of
support is required, but the challenge for the municipality is we can’t provide
it. We will bring the people to our cities. We will bring the institutions to our
cities, but that level of cooperation that has happened and is harnessed in an
entrepreneurial way, that’s going to really be driven by the organizations
themselves.
And that’s the challenge that we are going to have. That’s the biggest
challenge we are going to have. So, over the next little while, you are
certainly going to hear about cities investing in quality of life, marketing
themselves as the best place to live, marketing themselves as being the best
place to do business.
22
See example, Discover Windsor, http://www.visitwindsor.com/main.htm (last visited
Oct.
15,
2007);
Ontario
Yours
to
Discover,
http://www.ontariotravel.net/TcisCtrl?site=consumers&key1=home&language=EN
(last
23
See e.g., U of W Hosts Auto21, University of Windsor, Engineering News,
http://www.uwindsor.ca/units/eng/news.nsf/tovr/10974A3C9ED28F1185256CD0004B0615
(last visited Oct. 15, 2007); see also University of Windsor/DaimlerChrysler Canada
Automotive
Research
and
Development
Centre,
DaimlerChrysler
Canada,
http://www.chryslercanada.ca/CA/03/EN/CORPORATE/1,,CA-03-EN-CORPORATESOCIALRESPONSIBILITY-4_AUTOMOTIVERD.html (last visited Oct. 15, 2007);
Welcome Auto 21 – A Network of Centres of Excellence, Auto 21,
http://www.auto21.ca/home_e.html (last visited Oct. 15, 2007).
315
You are going to hear about universities and colleges saying come to us,
we will provide you with the best education. Come to us, we will provide
you the skills and tools that you need, but what we need here, what we want
to happen is that network that needs to be established, and that requires
collaboration and cooperation.
And from a Canadian perspective, we have a long way to go to do that. I
am not sure whether or not on the American side you are there yet. We do
have a number of opportunities that are in existence, but I am not sure where
that will go. But one thing I am certain of, in today’s economic climate,
today’s environment of three percent growth – three percent new growth in a
city in any region is done by 50 percent of the companies that are already in
the region.
And that’s what we need to have, and that’s why cities are always looking
to land a big plant – 1,500 to 2,000 jobs. That represents one percent of new
growth, and you are lucky if you get a plant. So that’s what we have to have
start happening into what’s existing in our own cities and regions. That’s
going to require this type of dialogue – this type of discussion. Do not expect
government to do it.
If I can leave you with one message: do not expect government to do it.
Government is too slow to respond to the needs of business, and I know that
because it is the biggest frustration that I live with everyday in my capacity
as a mayor. It takes way too much longer to bring everybody else on the
same page to execute a decision than it does from the private sector.
So it needs to be driven by the entrepreneurs. It needs to be driven by the
independent businesses in their respective communities. And that’s the key.
And thank you, that’s all.
I am perhaps the only mayor that I am aware of – we don’t have term
limits in Canada –
that is term limited. This will be my last term as mayor because I truly
miss private business. I truly miss the flexibility, the ability to get things
done as we do as entrepreneurs, and I am truly frustrated at the turtle pace of
things in government and the challenges that we face with the gridlock of
bureaucracy from time to time.
So moving forward, I would hope that with these types of discussions –
and I think this is a wonderful opportunity when you bring people together.
These types of discussions need to be held because this is how collaborations
are established in the true spirit of entrepreneurs. The true spirit of
entrepreneurs – the true spirit of businesses – the true spirit will really create
the type of movement that we want.
And so I thank each and every one of you for taking time from your busy
schedules to be here and participate. I know that you learned a lot and met
new people. My hope for each and every one of you in moving forward is
that you build on those relationships, and that we actually can work together
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[Vol. 33 No. 1]
to get things done. I know I am depending on it as mayor of the city because,
as the mayor of the city, it is your ideas and your cooperation that allow us to
do it.
So I am available for questions. If you have any questions I would
certainly be happy to answer them.
DISCUSSION FOLLOWING THE REMARKS OF HON. EDDIE
FRANCIS
DR. KING: Do you plan to go higher?
MAYOR FRANCIS: Do I want to move up?
DR. KING: Do you want to move up?
MAYOR FRANCIS: I could have all the aspirations in the world, Henry,
but my wife has other plans. You know, I get asked this question a lot, and
my answer sometimes – I am 32.
DR. KING: You have got a long way to go.
AUDIENCE MEMBER: You talked about the enormous amount of trade
between the two countries that crosses across the bridge. I was at a
conference two weeks ago, and we pondered the thought that if that bridge
were ever the target of an attack – what type of emergency preparedness or
contingency plans do Detroit and Windsor have to guard against that if, God
forbid, it would ever happen, to ensure that trade and commerce would
continue flowing?
MAYOR FRANCIS: The issue of the bridge: the bridge in DetroitWindsor is privately owned. I know that surprises a lot of people. But 28
percent of our trade crosses over a privately owned bridge,24 and there was
actually – there was a discussion group, I believe last year, and there was a
question to one of the Coast Guards in terms of, if the bridge is knocked
down, what happens to the economy, because we saw that post-9/11
everything came to a standstill.
Billions and billions of dollars were lost at the border because of that,25
and the question to the Coast Guard official was: in the event that there was
an event that took down the bridge or caused problems on the bridge, what
would happen?
And I think the response was: we table topped this, and the table top
exercise had shown that if the bridge was knocked down, there would be at
least a minimum of two weeks of complete cessation of the economy. Think
about that. The economy would come to a stop for a minimum of two weeks.
24
25
See Davey, supra note 17.
See id.
317
I am not talking about the economy of Detroit-Windsor. The economy
between the two countries would be at a stop for a minimum of two weeks.
Right now there is a movement afoot to get a new crossing located.
Prior to 9/11, in 1999, the Government of Canada together with the
province of Ontario, State of Michigan and Washington established what
they call the Bi-National Partnership, and the Bi-National Partnership was
charged with the responsibility of looking at the future trends – looking at
current traffic to try and determine what would be required to meet future
capacity for crossing the Detroit-Windsor corridor.26
Currently, there are approximately 9,000 trucks that cross that corridor
every single day,27 and as I mentioned, $150 billion of trade.28 By 2030, it is
projected that 30,000 trucks will be crossing that corridor.29
And that’s why they began the exercise in terms of trying to establish
when the next crossing will be built. Since then, they made some progress.
As I mentioned, some of my frustration has been the slow process. In
business, you would have had a new bridge up and running. You wouldn’t
wait for all the things that take so much time.
In government, you have to have a plan, study it, and you have got
politics. Right now they are projecting – this partnership is projecting to have
a new crossing built by 2013,30 and they hope to have all the studies done by
2010.31 And hopefully, there will be a new crossing by 2013.
But again, the challenge that they are going to have – and I can say this
because I am not part of the partnership – they have a private owner that is
going to do everything to block it. Interestingly enough, there is another
point, the Detroit-Windsor tunnel.
In 1930, the Detroit-Windsor tunnel was built as a connection between
downtown Windsor and downtown Detroit.32 When this was constructed in
26
See Canada and Ontario Improving Safety at Windsor Border, Government of Ontario,
Canada, Ministry of Transportation, http://ogov.newswire.ca/ontario/GONE/2005/05/27/
c4137.html?lmatch=&lang=_e.html (last visited Dec. 4, 2007).
27
See generally OCC BORDERS AND TRADE DEVELOPMENT COMMITTEE, COST OF BORDER
DELAYS TO ONTARIO (2004) available at http://occ.on.ca/Policy/Reports/121 (discussing
traffic and trade dollars crossing the United States, Ontario border including the DetroitWindsor corridor).
28
Id.
29
Id.
30
See Press Release, Ministry of Transportation, Windsor-Detroit International Crossing
Canadian
Environmental
Assessment
Phase
Begins
(Feb.
15,
2005),
http://www.tc.gc.ca/mediaroom/releases/nat/2005/05-gc003e.htm.
31
See generally id. (discussing the beginning of studies in regard to building a new
Detroit-Windsor crossing).
32
See A Vision for the Future, The Detroit and Windsor Tunnel Corp.,
http://www.dwtunnel.com/history.html (last visited Oct. 17, 2007).
177
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[Vol. 33 No. 1]
1930, the individuals that constructed it invested or had the vesting charter 60
or 70 years later, half to Windsor, half to Detroit.33
So we own the Canadian half. The City of Windsor owns the Canadian
half of the tunnel.34 It is a vital link because over 5,000 people cross into
Detroit every day: nurses, students and automotive employees go to work in
Detroit and come back.35 They use that facility to cross. It is an important
aspect to have in our region.
A year-and-a-half ago there was an attempt to try to sell the American
half to a private entity, same owner.36 Perhaps just this past Friday there was
an announcement that was made by Mayor Kilpatrick because for the past
year we have been negotiating with Detroit.37 The announcement that
Kilpatrick made this past Friday was that we reached an agreement in
principal between the City of Windsor and the City of Detroit. The City of
Windsor will be acquiring Detroit rights to the operation and management of
the tunnel – $75 million for a term of 75 years.38
But here is the question that I leave you with, and again, this is where I
struggle all the time in terms of being someone coming from the private
sector background, from an entrepreneurial background, from a business
perspective, you need to do this to protect your investment. If you don’t do
this, you lose your investment. If you don’t do this, you don’t provide for us,
you won’t be able to redirect the city into the future.
It becomes a challenge to communicate that to residents, to see that it is
$75 million, number one. That’s one issue of struggle.
Number two, why is it that the city, a municipal jurisdiction, is
responsible for securing a vital link of national importance? Why should the
taxpayer in the city – because again, my revenues are supposed to go – it is
very simple. I take in money from property tax. That money that I take in
should be used to service that property. It should be used to service sewers,
to service roads, to pickup garbage, to provide service to that property. The
money isn’t intended to provide for the national security of Canada and the
33
See generally id. (providing a detailed history of the Detroit-Windsor Tunnel).
Surface
Infastructure
[sic]
Programs-Bridges,
Transport
Canada,
https://www.tc.gc.ca/Programs/Surface/bridges/menu.htm (last visited Oct. 17, 2007).
35
See id.
36
See generally Firm Issues Bid for American Side of Detroit-Windsor Tunnel, Today’s
Trucking Online (June 1, 2007), http://www.todaystrucking.com/newscenter.cfm?pageaction=
story&intNewsCenterID=3&intDocID =17993 (discussing different bids for the Detroit side
of the Detroit-Windsor Tunnel).
37
Letter from Kwame M. Kilpatrick, Mayor, City of Detroit, to the Detroit City Council
(Apr. 12, 2007) http://www.ci.detroit.mi.us/budget/2007-08_Budget/Message/Mayors_%20
Speach.pdf (discussing Detroit’s agreement with Windsor regarding the operations and use of
the Detroit-Windsor Tunnel).
38
Id.
34
319
U.S. So those border issues are real, and those are border issues that we deal
with.
But going back to your point, the reason we do what we do is because
when senior orders of government are slow to move, somebody has got to
move, and that’s where the entrepreneur’s background comes into play.
I take donations, too, by the way.
AUDIENCE MEMBER: Thank you for taking the initiative.
MAYOR FRANCIS: Thank you.
AUDIENCE MEMBER: I am glad you included Ohio in the region you
govern. We are very similar to Windsor and Detroit. We have a Ford casting
plant – builds engines here – have two Ford assembly plants. We built a lot
of automotive plants. We have Chrysler, GM, and a lot of people around here
are worried because we don’t know what’s going on in Detroit.
We don’t see that there are – people are afraid of losing their jobs, and
you are a lot closer to Detroit. And one of the things you said was that there
is a reduction in our manufacturing base. We see the CEO of Ford taking $39
million for four months of work while people are losing jobs.39 People are
afraid for their jobs.
Being close to Detroit and being so tied in with the Detroit economy and
the regional economy, what do you know about what’s going on in Detroit?
And how can we preserve some of the jobs – many of the jobs – that we have
in this region?
MAYOR FRANCIS: I think our biggest – our challenge is similar to your
challenges here because you are dependent on manufacturing and very
dependent on the automotive sector. One of the things we have to recognize
is that we have to diversify our economy. One thing I do not want to see in
terms of all the challenges, all the struggles of the automotive manufacturing
industries – one thing that you have to recognize is that this region has a
qualified and a very highly-skilled work force.40
I don’t know of any other people that can take a line change or a new
product change and have it implemented in the time that you do it. It is
unheard of. The reason they are able to do that is because of the skill set they
have. So what we started doing in our city was try to diversify and also
change the mindset.
That’s a difficult thing to do, but we have gone to the advance
manufacturers that otherwise would have been servicing the automotive
industry, and we said to them, your skill set can be applied in other
39
See Ford CEO: $28M for 4 Months Work, CNNMoney.com (Apr. 5, 2007),
http://money.cnn.com/2007/04/05/news/companies/ford_execpay/.
40
See The Honorable Sandra Pupatello, Ontario Minister of Economic Development and
Trade, Why Isn’t Ontario, Canada, Facing a Skilled Labor Shortage? INDUSTRY WK. (Apr. 4,
2007), http://www.industryweek.com/ReadArticle.aspx?ArticleID=13882.
178
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[Vol. 33 No. 1]
industries. To date, we have applied manufacturers – advance manufacturers
– that were once only supplying the automotive industry that are now
supplying the aerospace industries, supplying airline industries, supplying the
medical fields.
Those type of skill sets are applicable somewhere else. Just like in
business, I would never give more than ten percent of my business to Costco.
What would happen if Costco went down? I would go down. You never put
all your eggs in the same basket. And the thing we need to do from an
automotive rich region is recognize that we have skill sets that no one else
has.
China doesn’t have the skill set that our region has.41 They don’t have the
same capacity and knowledge and innovation that we have here.42 What we
need to do is recognize that the automotive industry has gotten us this far,
provided us with these skills, and just like in business when you change
under different circumstances, we have to transition to applying those skill
sets to others.
I know it is difficult, and I have had over a thousand laid off from Ford,43
another thousand from Chrysler,44 but it is transition we need to work
together. One of the things we look for – and I apologize, I am not too
familiar with what American programs are available – but one of the things
we need to do on our side is take those individuals that have that skill set,
allow them to provide the support for the transition, upgrade the skill set, and
apply it somewhere else. Because, from our perspective, not only do we have
individuals that are in the skill set right now, right now I am third behind
Vancouver and Toronto.45 That’s unheard of.
And I have all these people coming into my city, and I need to be able to
provide them skills, but I can’t do it at the municipal level. R & D is a key
thing. I am telling you R & D. You know why the automotive industry is
struggling? It is very simple. It is all about product. Those companies that
have hot products, those companies selling the product, they come up with
great ideas. How do you come up with a great new product? R & D.
41
See generally Human Resources Trends, The US-China Business Council,
http://www.uschina.org/info/china-briefing-book/hr_backgrounder.html (last visited Oct. 17,
2007) (discussing China’s shortage of skilled labor).
42
Id.
43
See Chris Vander Doelen, 1,275 Auto Jobs Wiped Out, WINDSOR STAR, Apr. 5, 2007,
available
at
http://autos.canada.com/news/story.html?id=f3dce016-9f17-42f5-9cdfe2c110d9baeb.
44
Id.
45
See generally Allan Rock, Remarks at the Windsor Innovation Summit (Sept. 12, 2002),
http://www.innovationstrategy.gc.ca/gol/innovation/site.nsf/en/in02464.html (discussing the
Canadian government’s plan to strengthen the economy in part through building and
maintaining a skilled and knowledgeable workforce).
321
The idea goes back to what I was saying earlier. We need to attract people
that can have the ability to develop the ideas and then have the facilities to
take those ideas and turn them into a product. Those areas, and those regions,
that can do that, and this is where the R & D comes in. You need to have the
cooperation. I may have somebody that comes up with the idea, but I may
need somebody in Ohio to produce it. That’s where that cooperation and
collaboration comes in because then we can compete.
AUDIENCE MEMBER: You were 23 when this whole thing started. You
grew the business, went to law school, went on to council, and now you are a
mayor. This is in nine years. So you have done all this at an unbelievable
speed.
Do you have any interest in going back to the whole entrepreneurial
thing? You keep going at this space, you are going to run out of life times,
you know? But it would seem –
MAYOR FRANCIS: I feel like I am 72 on the inside.
AUDIENCE MEMBER: When did you sell the business?
MAYOR FRANCIS: I referenced in terms we have 10 or 11 months in a
law firm. So when I went to interview for Articles, I interviewed with a law
firm, and they said you are with city council. We are not going to give you a
job unless something gives, and I couldn’t get off council. I needed the
Articles to get called to the bar.
When I began the business and set it up and established it with my
brothers, we went in with a goal. Our goal was simple. Those people were
out there, and the people we were talking to thought we couldn’t do it. And
our job was to take out as much of the competition, and we brought so much
of that, and it came to a point that our competition was ready to buy us out.
AUDIENCE MEMBER: When did you sell?
MAYOR FRANCIS: In 2002.
AUDIENCE MEMBER: Is your father still alive?
MAYOR FRANCIS: Yes.
AUDIENCE MEMBER: What did he think about this?
MAYOR FRANCIS: My father is from the old country, and you still
can’t do it right.
AUDIENCE MEMBER: Would you go back to what I was saying,
yourself as an entrepreneur?
MAYOR FRANCIS: I miss it, and what I was trying to convey, perhaps
being in government right now when people ask you, there is no way to do it
in two terms. I miss it because government restricts the entrepreneurial
aspect. I feel so held back from doing what I normally do, and that’s being an
entrepreneur.
The thing I liked about being a lawyer, you get to be an entrepreneur in
everybody else’s business, so you learn about so many different clients and
different businesses that you are an entrepreneur and in a different business
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[Vol. 33 No. 1]
everyday. That’s what I enjoyed about the law; it gave me that same type of
opportunity to channel that energy.
AUDIENCE MEMBER: You are still young, and you have a chance to be
prime minister, but it seems you have that ability.
MAYOR FRANCIS: You really have to meet my wife. She doesn’t want
any part of it.
AUDIENCE MEMBER: You may have a chance to make Canada, as an
entrepreneur, as a great country of the world. Think about that.
MAYOR FRANCIS: And thank you. That’s very kind, but go back to my
earlier point: we cannot depend on government to do it. Government will not
do it. And again, I am speaking from a very limited experience in terms of
my perspective as a mayor. It just takes way too long.
The entrepreneurial spirit needs to be driven by entrepreneurs. It needs to
be driven by business and small business, and they will do it. What we need
to do as government is be able to provide them the type of support that
otherwise they wouldn’t be able to get.
I will give you an example. Shortly after being elected – and this is some
of the conflicts I face – shortly after being elected, there was an opportunity
for us to locate a company, International Truck. Are you all familiar with
International Truck? To locate their new R & D center, and Windsor was one
of the places, and International Truck was going to make a decision.
I think it was Windsor, Hamilton, London, and Toronto, and they had
three R & D facilities they were going to locate. And I asked for a meeting
with the powers that be, and I met with them. I just said, “What do you
need?” They said, “What do you mean?” I said, “What do you need for you
to make your decision?” They said, “We never heard that before.”
I said, “Tell me what it is, and if I can do it, I will do it, but what do you
need in terms of us providing the support?” They told us. They made their
decision, and they are now located in Windsor. As government, we need to
be able to approach business and not with the same cookie cutter approach –
this is the way it needs to be done.
Their situation may be different than your situation, so what is it for you
to do? What is it you need to do, and develop that type of a product, that type
of idea, that type of entrepreneurial invention? And if we can provide the
support, that’s what we need to do. I think we are doing a good job in terms
of getting there. Mark is a good example. He does it every day.
AUDIENCE MEMBER: I know that you might be frustrated by your job
and how you feel you are constrained in what you could accomplish, but you
probably are also saying to yourself, “I accomplished a hell of a lot in the
term-and-a-half or almost two terms as mayor.” Anybody can be proud of
what you have accomplished and is going to be concerned about making sure
that the next person who comes in takes what you have done and takes it to
the next level. You want to get somebody in there even better than you.
323
So my question is: what’s your sense of the landscape, the political
landscape in the Windsor area, apart from your two brothers, in terms of
talent that can make it look like you were only half as good?
MAYOR FRANCIS: You must have been talking to my two brothers.
I think the best – I am confident – let’s put it that way. I think if anything,
when somebody comes into the office and is able to accomplish something,
set the bar high and hope somebody else will do better, I am confident that
will happen. Any good person who steps into a political office sets things in
place that you would hope would serve as the building blocks.
And if anything, I would hope that by being a nobody that was fortunate
to be elected, that has inspired or has given reason for others to move
forward that otherwise would not have considered politics but can now
consider politics.
So I would hope that my example – and that’s why every time I have an
opportunity to speak I say you don’t have to be a politician to run for office.
You just have to have dedication and passion and the commitment to do a
better job than the next guy. I hope that after I am done the next person that
comes in, within a year they forget about me because the next person is that
much better.
Questions.
AUDIENCE MEMBER: What personality traits attract you in
succeeding, and if you don’t have those, can you still have those by having a
good plan and executing it?
MAYOR FRANCIS: It is a good question. Believe it or not I am a very
shy individual. It is true. So the personality – you know what? I have never
been asked that question in my career. The personality traits, I think, that
have helped me are being able to be very – and this comes from my science
background – science, they teach you to be very methodical, right? Know
what your end result is going to be. Map out how you are going to get to your
end result, and that’s the same thing I applied in business.
The same thing I applied in my career as mayor. I am methodical in terms
of establishing a long-term, direct, knowing where it is I think we need to be,
developing a plan and sticking to it. Oftentimes you will get politicians that
get swayed one way or the other, and it just doesn’t happen.
You stick to it, and if you believe in your plan so much that it is the right
thing to do, you just get it done. Patience is a key thing for me, and I still
struggle with patience sometimes.
Thank you.
180
WHERE DO WE GO FROM HERE?
SPEAKER
DR. KING: We learned a lot tonight. Thank you very much, and we hope
you will be back again.
MAYOR FRANCIS: Thank you.
DR. KING: And maybe you will be in a higher office.
Well, this is a time when we usually discuss the programs for the future. I
am not going to do it tonight because the hour is late, but I would like to
solicit your suggestions for next year’s program. My feeling is to write me a
quarterly or give me an e-mail. I think what we ought to be concerned about
is the tightening of the Canada-U.S. border. After all, the European
community is breaking down borders all over Europe, and we should be
concerned about the tightening of the Canada-U.S. border. Another
alternative would be the Canada-U.S. border problems and progress, so you
can take both sides. This could cover various subjects like, certainly, border
security, immigration, NAFTA, Great Lakes, and many other areas. It is a
good umbrella topic. But there is nothing to do tonight but give me your
suggestions, and I think that’s very important because the Executive
Committee of the Institute will be meeting on May 31 to discuss this.
But let’s have your voice because you are our constituency. You are our
market, and let’s hear from you. But my feeling is the border ought to be the
subject in some way or another and trade foes. I think it should be the
product manufactured in Canada, how it goes across the border, what the
barriers are, what concerns people have.
The work of the Institute could not happen without a number of people. I
would like to thank our students, first Payal Deora. She served as Editor-inChief of the Canada-U.S. Law Journal. She ran the Niagara Moot Court. She
was our Executive Student Director. We have never had a student like her.
And we will miss her. Thank you, Payal. Thank you, again.
Chris Kringel was our Managing Editor of the Canada-U.S. Law Journal.
He did a great job. The Journal has a new look, which you have seen. It is in
color now. Our number of subscribers has increased and we now publish two
issues per year. Thank you, Chris, and stand up. Good job.
Mark Bardwell has been a source of support as a Student Director as has
Jerrick Ho. These two students were leaders of our conference as well as
325
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[Vol. 33 No. 1]
worked on our programs in Toronto and Washington. Thank you, and please
stand if you will. Mark, I want some of those photographs that you have been
taking.
I thank Krista Neilson, Sara Paulett, Steve Rodini, and Mark Siegel for
their services as student Executive Editors, and I want to thank the second
year law students: Kyle McCoy, Pragati Nayak, Adam Roberts, Megan
McCarthy, Kelly Schmidt, Monty Silley, Asim Khan, Will Randall, Matthew
Weinbaum, and Michael Jones. I look forward to their involvement next
year, and we thank them for their work this year. Will they stand?
We thank Tim Martin and David Wright for their work with the
audiovisual equipment.
And we thank you, Deborah Turner. She is an outstanding asset of the
institute. This was her first conference, and you all know her skill and talent.
Thank you, Deb.
I thank Chi Carmody for his leadership as well as that of the Advisory
Board and the Executive Committee as we continue to grow. We have new
programs; and I thank you for your leadership.
We again thank Dean Brown who is right here, if you want to stand, Dean
of University of Western Ontario, and Dean Simpson of Case for their efforts
and support.
And above all, I want to pay high tribute to Dan Ujczo. He has been
outstanding in every way, and he has been a wonderful right hand for me. I
am now going to turn to Dan for a few announcements. Dan, don’t make it
too long. We want to get out of here.
MR. UJCZO: Well, good evening, and, again, we want to extend, on
behalf of the Institute, our deepest appreciation to Mayor Francis for taking
time from both his busy professional schedule as well as, with a new child on
the way, personal schedule. So we express our deepest appreciation to you
for coming down on a beautiful Saturday in Cleveland, Ohio.
Indeed, we express our heart felt thanks to all of other speakers, session
chairs, and participants for a weekend – dare to say – one of the best
conferences that we have had in the 30-year history of our Institute. That is,
in large measure, due to your contributions throughout the weekend, both
during the substantive portion of the program as well as a great deal of the
networks that were established during meals and cocktails, et cetera. So we
thank you.
We know that many of you will be going to your chiropractors this
weekend. There was a theory here a decade ago, when I was in law school,
that when they put the chairs in the moot courtroom they were designed so
students wouldn’t fall asleep. They haven’t improved it in a decade. But I
have been told there is going to be a massive renovation, so next year when
you are back, hopefully, we will have some new chairs.
King & Ujczo—Where Do We Go From Here?
327
We again express our thanks to the Advisory Board as well as the
Executive Committee for their leadership and support, financial and
otherwise, for our programs, not just this program but for the entirety of the
programs that we discussed over the past several days.
As Henry mentioned, the Executive Committee will be meeting in late
May to map out our future programs in the next year, so if you do have any
suggestions, please know that the phone, the e-mail and the fax lines are
always open. We are here as the Institute staff to take the ideas and advice
that you have and put them into implementation as well.
I would again like to thank Deborah – and I don’t want to expound on
Henry’s comments – but the only thanks that I can give to you, Deborah, and
the only way that I know how is: Deborah will not be in the office on
Monday and Tuesday having a much deserved rest.
Now, Henry has gone through the list of students that we have thanked,
and I want to introduce you to the student leadership for next year in a
moment, but there are several announcements.
First and foremost, please remember – I know that several of you will be
exploring the sights and sounds of Little Italy. The gate at the parking garage,
I had a personal experience, but we had an incident with the University
Circle Police Department who are not a fan of Dan right now after they got a
call to get them to open the gate.
With your CLE materials, please ensure you see Deborah so she can get
you entered for your 17 and-a-half credit hours.
Finally, Dick Getz mentioned he thinks the only thing we haven’t done is
put the Canada-U.S. logo brand on tennis shoes, and now we have. And I
think we have the perfect audience to help figure out the business plan. We
encourage you to take those for your personal and professional cabinets.
Again, it is, somewhat, tonight that I have mixed emotions. As you have
you heard, we expanded our programs over the years, and it has largely been
with the student group that are now third years advancing on into the real
world. But we do wish our third-year students the best as you move on to
finals for your third-year. You will have that exam in a few months. We all
loved our bar exam experience. The only thing worse than that experience is
the letter you get three months later explaining that your student loan is over,
and you have to write the first check. I am extremely confidant the Alumni
Association calls a week later, also. But on behalf of the Canada-United
States Law Institute, if there is anything we can do professionally, don’t
hesitate to give us a call, or any of the individuals on boards or our Executive
Committee as well.
We will proceed publishing the proceedings in the annual Canada United States Law Journal.
This weekend’s issue should come out in the fall, and the students that I
will now introduce will be those students for leadership for next year: The
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[Vol. 33 No. 1]
Editor-in-Chief is Megan McCarthy, and the Managing Editor is Kelly
Schmidt. The Special Issue Editor, which will be a book we are publishing
on the joint working groups of CBA ABA; that three nations can produce and
work in a collaborative manner, and that Special Issue Editor will be by Kyle
McCoy.
And the following individuals will serve as our Executive Editors. They
are Adam Roberts, Asim Khan, Matthew Weinbaum, Michael Jones, Pragati
Nayak, Monty Silley, and Will Randall. If you could all stand up, they will
be joined by 16 to 20 rising 2Ls. Those are students that are presently in their
first year, and we don’t talk to them at this time of the year because stress is
at an all time high with those individuals. But they will be joining the
Journal likewise.
Our staff at the University of Western Ontario, likewise, will be selecting
students to be involved in those. We do have four students, which, as Henry
mentioned, help run the Niagara Moot Court, and I am pleased to announce
that the Executive Student Director will be Kyle McCoy. He will be joined
by two associates who will be part of our exchange program next year. I
assigned two associates to you that won’t be here, but congratulations.
And there are legions of many other individuals who have assisted with
our program.
And I want to thank my great friend, who is not only my professional
friend, but I can tell you that the first phone call I get every Monday morning
is from this individual, to ask me how my Ohio stay was, and that’s my 87year-old friend and former Nuremberg figure, and that’s Henry King.
Henry, we just offer you our deepest and most heartfelt thanks.
DR. KING: Thank you very much.
MR. UJCZO: The bar area will be open for the next couple of hours, so
don’t hesitate again to socialize and enjoy the camaraderie that, of course,
will take place.
And without further ado by the powers vested in me, I hereby declare that
the Annual Conference adjourned.
Thank you.
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